Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ

Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ

Indicate by check mark whether the registrant: (1) has
filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past
90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any
amendment to this
Form 10-K. o

Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2 of the
Exchange Act.

Large Accelerated
Filer o Accelerated
Filer þ Non-Accelerated
Filer o

Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2 of the
Exchange
Act). Yes o No þ

At March 1, 2006, the aggregate market value of the voting
and non-voting common equity held by non-affiliates (meaning all
shares not beneficially owned by directors or officers of the
registrant) was $143.1 million (based on a price of
$12.84 per share, which was the closing price of the
registrants common stock on the Nasdaq National Market on
the last business day of the registrants most recently
completed second fiscal quarter).

We had 20,294,903 shares of common stock outstanding at
March 1, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

Pursuant to General Instruction G(3), Part III,
Items 10, 11, 12, 13 and 14 incorporate by reference
information from the Proxy Statement for the Registrants
2006 Annual Meeting of Stockholders, which will be filed with
the Securities and Exchange Commission within 120 days of
the end of the fiscal year ended December 31, 2005.

This report includes forward-looking statements. All statements
other than statements of historical facts contained in this
report, including statements regarding our future financial
position, business strategy and plans and objectives of
management for future operations, are forward-looking
statements. The words believe, may,
will, should, could,
estimate, continue,
anticipate, intend, expect,
plan, potential, predict and
similar expressions, as they relate to us, are intended to
identify forward-looking statements. Forward-looking statements
contained in this report include, but are not limited to,
statements relating to:



our future financial results;



our future growth and expansion into new markets;



our future advertising and marketing activities; and



our future investment in technology.

We have based these forward-looking statements largely on our
current expectations and projections about future events and
financial trends that we believe may affect our financial
condition, results of operations, business strategy and
financial needs. These forward-looking statements are subject to
a number of risks, uncertainties and assumptions, including
those described in Risk Factors in Item 1A of
Part I. No forward-looking statement is a guarantee of
future performance and you should not place undue reliance on
any forward-looking statement.

In light of these risks, uncertainties and assumptions, the
forward-looking events and circumstances discussed in this
report may not occur and actual results could differ materially
from those anticipated or implied in the forward-looking
statements. Except as otherwise required by law, we undertake no
obligation to update or revise any forward-looking statement
contained in this report.

ZipRealty, ZipAgent,
ZipNotify and Your home is where our heart
is are our registered trademarks in the United States.
REALTOR and REALTORS are registered
trademarks of the National Association of
REALTORS®.
All other trademarks, trade names and service marks appearing in
this report are the property of their respective owners.

Internet Site

Our Internet address is www.ziprealty.com. We make
publicly available free of charge on our Internet website our
annual report on
Form 10-K,
quarterly reports on
Form 10-Q, current
reports on
Form 8-K, and
amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of
1934 as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the Securities and
Exchange Commission. Information contained on our website is not
a part of this annual report on
Form 10-K.

Where You Can Find Additional Information

You may review a copy of this annual report on
Form 10-K,
including exhibits and any schedule filed therewith, and obtain
copies of such materials at prescribed rates, at the Securities
and Exchange Commissions Public Reference Room in
Room 1580, 100 F Street, NE, Washington, D.C.
20549-0102. You may obtain information on the operation of the
Public Reference Room by calling the Securities and Exchange
Commission at
1-800-SEC-0330. The
Securities and Exchange Commission maintains a website
(http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding
registrants, such as ZipRealty, that file electronically with
the Securities and Exchange Commission.

We are a full-service residential real estate brokerage firm,
using the Internet, proprietary technology and efficient
business processes to provide home buyers and sellers with
high-quality service and value. Our solution includes a
client-centric business approach, a sophisticated website that
empowers home buyers and sellers with relevant information, a
proprietary business management technology platform and
significant financial savings for consumers. With operations in
16 major metropolitan areas, we employ over 1,350 sales agents,
known as ZipAgents, all of whom are licensed in their local
markets, are members of the National Association of
REALTORS®,
or NAR, and work for us on an exclusive, full-time basis. We
believe that this unique employee-based model in an industry
characterized almost exclusively by independent contractors
provides us with a distinct competitive advantage in being able
to consistently deliver outstanding service to our clients.

Through our website, registered users can access a broad range
of current information and powerful tools to research and
commence the process of buying or selling a home, including
direct access to comprehensive local Multiple Listing
Service(s), or MLS(s), home listings data, such as asking
prices, home layouts and other features. Each MLS is a database
of available homes listed for sale by participating member
agents to facilitate broker cooperation. We also provide
information in addition to MLS data, including neighborhood
attributes, school district information, comparable home sales
data, maps and driving directions. We attract users to our
website through a variety of marketing channels, including
online advertising,
word-of-mouth and
advertisements in traditional media.

Our proprietary ZipAgent Platform, or ZAP, automatically matches
registered users with our local ZipAgents who market and provide
our comprehensive real estate brokerage services, including
showing properties to our buyers and listing and marketing
properties on behalf of our sellers, as well as negotiating,
advisory, transaction processing and closing services. Our ZAP
technology also includes a customer relationship management
system that identifies and analyzes user behavior on our website
allowing us to provide more relevant information and service to
clients and a business management system that allows our
managers to monitor the activities of our ZipAgents to ensure a
high level of client service. According to a 2005 survey by the
California Association of
REALTORS®,
89% of home buyers who used the Internet as an important part of
their home buying and selection process were very satisfied with
their agent experience, compared to only 36% for traditional
home buyers who did not use the Internet as an important part of
their process.

Our business was founded in 1999 and has grown rapidly since
inception. We generate revenues principally from earning
brokerage commissions in connection with representing buyers and
sellers of residential real estate. In 2005, we generated
$93.4 million in net revenues, compared to
$62.3 million in 2004, $33.8 million in 2003,
$17.2 million in 2002 and $4.0 million in 2001. As of
December 31, 2005, we had over 825,000 active registered
users who had accessed our website within the last twelve
months, and since our inception we have closed over 30,000 real
estate transactions with an aggregate transaction value of
approximately $10.3 billion. We currently have operations
in Atlanta, Baltimore/ Washington D.C./ Northern Virginia,
Boston, Chicago, Dallas, Los Angeles, Orange County, Phoenix/
Scottsdale, Sacramento, San Diego, the San Francisco
Bay Area, Seattle, Las Vegas, Houston, Miami and Tampa. We
currently plan to begin operations in Orlando and Minneapolis in
2006 and intend to open one to three additional markets later in
the year.

INDUSTRY BACKGROUND

The U.S. residential real estate market

The residential real estate industry is one of the largest in
the United States. According to REAL Trends, an industry
research firm, residential real estate sales totaled over $1.96
trillion in 2004. Also according to

REAL Trends, sales of existing homes comprise the vast
majority of the residential real estate market, accounting for
$1.61 trillion of 2004 total home sales. Additionally, REAL
Trends reported that total residential real estate
brokerage commissions and fees, which are primarily derived from
existing home sales, were approximately $61.1 billion in
2004. We believe that favorable demographic, cultural and
economic trends have contributed to consistent long-term growth
in the residential real estate industry. From 1983 to 2005, the
residential real estate industry grew at a compound annual
growth rate of 10% in terms of aggregate sales volume.

The residential real estate brokerage market is highly
fragmented. According to REAL Trends, the 10 largest
brokerage firms accounted for approximately 10% of all brokered
residential real estate transaction volume in 2004, and the
single largest firm accounted for less than 5% of total
transaction volume. According to NAR, there are in excess of
1.2 million members of NAR in the United States.

Some brokerage firms are affiliated with national franchise
brands, such as Century 21, Coldwell Banker, Prudential and
RE/ MAX. The franchise brands typically do not directly own and
operate brokerage firms, but rather license their brand names
and trademarks and provide other marketing support to franchisee
brokerage firms. These brokerage firms typically engage agents
to work for them as independent contractors and as a result
franchisors and franchisees have limited direct influence over
the client relationship or the quality of client service.
Brokerage firms associated with the eight largest brands
accounted for slightly less than 50% of total brokered
transaction volume in 2004 according to REAL Trends.

Traditional real estate transaction process

The traditional real estate transaction process centers on real
estate agents, who act as the principal intermediary between
home buyers and sellers and control the flow of information to
both. Prior to the relatively recent influence of the Internet,
prospective home buyers and sellers would typically rely on
their agents, word of mouth, newspapers and local publications
for information regarding homes available for sale. Information
presented in traditional media has historically been limited,
often consisting of only a single photo and a brief description.

In order to gain access to a broader range of information,
prospective home buyers would typically engage an agent. One of
the primary benefits traditionally offered by an agent is access
to MLS home listings data and the ability to search and filter
that data based upon specified criteria. Because consumers have
not traditionally had direct access to this data, the agent has
primary control over the process of searching and filtering the
MLS data under this system. Consequently, consumers cannot be
assured of access to comprehensive and relevant information.
Prospective home buyers rely on the agent to identify and show
them relevant properties and typically spend a great deal of
time physically viewing these properties. Therefore consumers
may spend unnecessary time visiting homes that they would have
decided not to visit, and may fail to visit homes that would
have been of interest, if they had access to more comprehensive
information.

Traditionally, prospective home sellers have had similarly
limited opportunities to investigate the current market or to
efficiently and effectively market and sell their homes. Sellers
would typically call a local agent to list their home for sale
and would rely on that agent to give them guidance on the market
value of the home and the most effective manner to successfully
market and sell the home. The agent would then enter into an
exclusive listing agreement with the seller and post the
property for sale in the local MLS. Commissions vary from market
to market, but generally range from 5% to 6% of the total sales
price of the home. Many agents and brokerages are reluctant to
compete on price and instead rely on historical market
commission percentages to set their rates. The commission is
paid by the seller at the closing and is typically split between
the buyers agent and the sellers agent.

Increasing use of the Internet in the residential real
estate transaction process

Consumers are increasingly using the Internet as a key source of
information in buying or selling a home. The 2005 National
Association of Realtors Profile of Home Buyers and Sellers cites
that buyers use of the Internet to search for homes has
increased, rising from 71% in 2003 to 79% in 2005. The Internet
provides a highly effective means for consumers to research
information about homes in an industry that is data intensive

yet historically has suffered from a lack of broad access to
comprehensive and timely property listings information for
consumers. The interactivity of the Internet also allows
consumers to better conduct targeted searches and research
relevant data about desired homes or areas. The ability to
provide multiple images and rich media makes the Internet a
highly effective means for brokerage firms to market and
consumers to research homes.

Challenges and limitations of the traditional residential
real estate process

We believe that the traditional residential real estate industry
is characterized by a number of challenges and limitations,
including:

Challenges for home buyers and sellers. We believe that
the traditional residential real estate industry is
characterized by low levels of client satisfaction. Some
contributing factors include:

ownership and management of client relationships resides with
the agents; and



low levels of client and agent loyalty.

OUR BUSINESS MODEL

We are a full service residential real estate brokerage firm
using the Internet, proprietary technology and efficient
business processes to provide home buyers and sellers with
high-quality service and value. We believe that we have
developed a unique client-centric approach to the residential
real estate brokerage process. The key attributes of our
solution include:

Addressing challenges for home buyers and sellers

We use the Internet to empower consumers. Through our
website, we empower our registered users with comprehensive,
free and unrestricted access to all currently available home
listings posted on the MLSs in our markets and the ability to
research and compare homes. Our MLS data is updated at least
once per day in each of our markets. We also provide valuable
information and services to potential home buyers through our
website, such as home and neighborhood content, automated
screenings and notifications of available homes that meet
specified criteria, the ability to schedule home viewing
appointments or make offers online and financing pre-approval.
We offer home sellers online comparative marketing tools and
virtual tours, as well as broad marketing distribution through
the Internet and traditional media.

We focus on delivering high-quality service with a
client-centric approach. Our solution is built around the
client, not the agent. We acquire a majority of our client leads
and provide ongoing value-added services

through the Internet, allowing us, rather than the agent, to
control the client relationship. With our employee model, we
hold our agents accountable for consistently delivering a high
level of client service and satisfaction. We monitor each of our
ZipAgents through our ZAP technology to ensure a high level of
responsiveness and enable us to quickly address any potential
issues. To back up our commitment to client service, we offer
our clients a $250 cash refund if they are unsatisfied with our
services. In addition, our clients can influence the
compensation paid to their ZipAgent based upon the results of a
client satisfaction survey.

We offer a compelling consumer value proposition. Our use
of the Internet, proprietary technologies and efficient business
processes allow us to offer significant cash rebates to our
buyers and reduced commissions to our sellers. We presently pay
each of our home buyers an amount equal to 20% of our commission
in cash upon closing and offer our home sellers up to a 25%
discount off of standard commissions in their particular market.

Addressing challenges for agents and brokerage
firms

We use proprietary business management technologies and
processes to increase operational efficiency and provide
excellent client service. Our proprietary ZAP technology
utilizes the interactivity, broad availability and efficiencies
of the Internet to allow us to increase ZipAgent productivity.
After a new client completes the registration process, our ZAP
technology automatically monitors the clients searching
behavior from the initial search session and assigns that client
to a ZipAgent who specializes in the specific territories most
frequently searched by that client during that initial session,
or in the territory where the property to be sold is located.
Only leads that are qualified, meaning that the client has
completed the registration process and has conducted at least
one home search or owns a property to be sold in an area in
which we do business, are assigned to our ZipAgents, allowing
our agents a steady flow of clients who are searching in the
territories in which they specialize. Our ZAP technology also
provides a system for organizing and prioritizing these leads,
valuable customer relationship management, or CRM, tools and
visibility into client website behavior. Our ZAP technology also
allows our managers to observe and manage how our ZipAgents are
servicing our clients. We also have proprietary transaction
support tools and a dedicated group of service professionals to
help our ZipAgents close transactions more efficiently. We
believe our integrated consumer website and ZAP technology are
difficult to replicate and allow us to manage employees
effectively, rapidly scale our business to meet client needs,
and provide outstanding client service.

We offer a compelling value proposition to agents. We
believe our employee-based model and ZAP technology offer a
unique and attractive proposition to agents compared with that
found at traditional brokerages, including the ability to work
more efficiently and close more transactions. We design,
implement and bear the cost of all marketing programs for our
ZipAgents, including the delivery of a steady flow of client
leads, allowing them to focus on serving clients rather than
generating new business. Additionally, all of our ZipAgents
receive comprehensive initial training and participate in
various ongoing training activities. All of our ZipAgents are
full-time ZipRealty employees and after completing six months of
employment are eligible for employee benefits including
company-sponsored health, welfare, retirement and equity
incentive plans. We believe that a number of factors contribute
to our ZipAgents ability to close more transactions than
is typically achieved in the industry, in particular:



our ZipAgents receive a steady flow of qualified leads without
individual marketing efforts, allowing them to rapidly develop a
good pipeline of clients;



our ZAP technology, with its proprietary CRM tools, allows our
ZipAgents to remain organized and communicate and sell
effectively with numerous clients at the same time; and



our system includes closing support infrastructure that allows
our ZipAgents to spend less time on closing tasks and more time
on new clients than they would otherwise be able to without this
support in place.

Our ZipAgent productivity has consistently exceeded that
typically achieved by agents in the industry. We estimate that
the average monthly productivity of real estate licensees
nationwide was approximately 0.5 transactions in 2005. We
calculate the average agent productivity in the industry by
dividing the average

estimated monthly number of brokered transactions closed during
the year by the average number of total active real estate
licensees. According to the Association of Real Estate License
Law Officials, the number of active real estate licensees
approximated 2.1 million at the end of 2005 versus
approximately 1.8 million at the end of 2004. The average
productivity of our total agent population was approximately 0.9
transactions per ZipAgent in 2005. For full years 2002, 2003,
2004 and 2005 the average monthly productivity of our ZipAgents
ranged from 0.9 to 1.3 transactions per ZipAgent. We calculate
the average monthly productivity of our ZipAgents for a full
year by dividing the average monthly number of transactions
closed during the year by the average number of ZipAgents
employed at the beginning of each quarter in the year. We do not
adjust the denominator for ZipAgents hired during the quarter,
because closing transactions in the first three months of
joining us is difficult given the time lags involved in the real
estate closing process. The productivity level of our ZipAgents
who have been with us in excess of three full months is
considerably higher than the average level achieved by all our
ZipAgents. We also do not adjust the denominator for ZipAgents
who leave us during the quarter.

OUR STRATEGY

Our objective is to become one of the most recognized, respected
and successful companies in the residential real estate
industry. The key elements of our strategy include:

Broaden and deepen our presence in existing markets

We plan to increase our presence and market share in existing
markets by expanding our number of ZipAgents and growing our
home listings business. While our focus historically has been on
buyers, we intend to grow our home listings business in a number
of ways, such as by developing more website tools for sellers,
implementing a referral system that encourages ZipAgents and
clients to refer home listings and using dedicated listing
specialists. We also intend to increase our penetration into the
higher-priced home segment.

Enhance the ZipRealty brand

We believe that enhancing the ZipRealty brand will heighten
awareness of our company and increase the number of home buyers
and sellers who use our services and ultimately increase the
number of transactions that we close. We plan to increase our
brand awareness by increasing our
word-of-mouth marketing
through such initiatives as growing consumer awareness of
ZipRealty in the blogosphere, the increased use of our
refer a friend feature and continued strong press
coverage and media attention. In addition, we believe that we
can enhance our brand by continuing to focus on client service,
with the objective of creating lifelong relationships with our
clients.

Continue to invest in technology and our people to
increase operational efficiency

We plan to continue improving our proprietary technology
platform to increase ZipAgent productivity and provide
consistently high levels of client service and satisfaction. We
intend to continue to design tools that help our ZipAgents
better qualify and prioritize leads and identify levels of
client responsiveness and implement communication services that
allow our ZipAgents to be more responsive and productive. In
addition to enhancing our technology, we intend to continue to
refine our recruiting and training programs and provide our
ZipAgents with additional field support in an effort to continue
increasing ZipAgent productivity. Our centralized infrastructure
is designed to enable us to rapidly expand our business and take
advantage of economies of scale.

Expand operations into new geographic markets

We believe that there is a significant opportunity to expand our
services into new geographic markets represented by over 250
U.S. metropolitan statistical areas, or MSAs. We currently
operate in 16 major metropolitan areas, including 14 of the top
25 U.S. MSAs. We currently plan to begin operations in
Orlando and Minneapolis in 2006 and to open one to three
additional markets later in the year. We are currently
evaluating the relative attractiveness of other markets and
developing entry strategies and timelines. In

determining which markets we intend to expand into and in what
order, we consider a variety of criteria, including
demographics, business climate, housing market, competition,
technology fit and regulatory environment. Currently, several
states prohibit sharing any commissions with, or providing
rebates to, clients who are not licensed real estate agents. In
addition, other states may limit or restrict our cash rebate
program as currently structured. Should we decide to expand into
any of these states, we may have to adjust our pricing structure
or refrain from offering rebates to buyers in these states.

Continue to improve the client experience

We believe that ongoing client satisfaction is critical to our
continued success and future growth. As a result, we continually
focus on improving the client experience on our website and with
our ZipAgents. In addition to enhancing the functionality of our
website, we plan to provide additional information to home
buyers and sellers, improved personalization and search features
such as comparison and market analysis tools, additional seller
tools to improve our listings business and enhanced image
capabilities.

OUR CONSUMER WEBSITE AND SERVICES

Our real estate services enable consumers to control the home
buying or selling process from the comfort of their home or
office. Consumers enjoy an Internet-enabled,
easy-to-use approach to
the real estate process and have access to a team of local
ZipAgents. Our ZipAgents typically have extensive market
knowledge of the metropolitan areas they serve and are required
to be active members of their local, state and national real
estate and MLS associations. In addition, our website,
www.ziprealty.com, provides a step-by-step approach to guide
clients through the home buying and selling process. Our website
and agent platform software is proprietary to us. We enhance our
website by including information such as home listings,
neighborhoods and recent home sales that we obtain from local
MLSs and other third party providers.

Comprehensive MLS access for home listings data

We offer individuals who register on our website access to
comprehensive available home listings data, including pictures,
from the local MLSs in the markets in which we operate. As
active members of the MLSs in the markets we serve, we organize
the data from each MLS database and provide it directly to
consumers on our website. Unlike many real estate websites, we
show listings from all broker participants in the MLSs, not just
our own listings. We update this data frequently, often multiple
times daily. Our website is password protected, so only
individuals who provide basic registration information, agree to
our terms of use and then return to our site to input a code
which we email to them at the time of their registration are
able to access comprehensive home listings data. Consumers can
search for homes based upon numerous criteria, including
location, price, square footage, number of bedrooms and
bathrooms, map geography, distance from a specified address, and
other characteristics and amenities such as lot size, whether a
home has a fireplace or central air conditioning, and numerous
other features. We do not show information from the MLS
databases that is marked as confidential, such as information
relating to home security.

ZipNotify

One of our most popular consumer website tools is called
ZipNotify, which allows consumers to receive an automatic email
notification each time a property which meets their desired
search criteria is listed on the local MLSs. Since we update our
listings information at least once per day in each market, our
registered users are able to learn about new listings in a
timely manner. In markets that are characterized by short
supply, this tool provides our clients a competitive advantage
over other consumers who might have to wait for their agent to
learn about the listing and then contact them with the
information. The ZipNotify tool is also interactive, so with one
click the consumer can login to see more detailed information on
the home, schedule a visit with one of our ZipAgents to see the
home, or send an email to one of our ZipAgents requesting more
information about the property. Our number of ZipNotify messages
has grown steadily, and averaged over 12.2 million per

month in the fiscal year 2005 compared to over 5.4 million
per month in the fiscal year 2004 and 2.3 million per month
in the fiscal year 2003.

Neighborhood data and related information

Our system is designed to provide consumers with access to a
broad range of information in addition to the MLS data about
their potential home without having to rely on an agent or other
party to provide that information for them. Consequently our
website includes several tools to help our clients educate
themselves during the process, including relevant neighborhood
data such as population, comparable home sales, average income,
education level, occupation mix, cost of living, crime
statistics, weather, school district information, maps and
driving directions.

Online images and virtual tours

We believe that one of the principal attractions of the Internet
for consumers researching homes is the ability for consumers to
view images of available homes. For our seller clients, we offer
virtual home tours and photos of our home listings at no
additional cost. For our buyer clients, in addition to the
customary single photo, in select markets we have the ability to
post multiple property photos from the local MLSs, giving
clients a more robust search experience. This enables home
buyers to better research homes before deciding whether to visit
them.

Schedule visits

We try to make it as easy and convenient as possible for our
buyer clients to schedule visits of properties they would like
to see. All a client has to do is click on a button when viewing
information about a home on our website and enter in their phone
number and what day(s) and time(s) they would prefer to see the
home. We then contact the listing agent and organize the visit
for our client. Alternatively, our clients can contact their
ZipAgent by telephone or fax to schedule a visit.

Home offers

While the vast majority of clients prefer to make offers through
their ZipAgent, some clients like the convenience and speed of
submitting their offers online. We provide this capability
through our website by allowing clients to input all of the
relevant information into our offer form. We then fill out the
appropriate paperwork and obtain signatures from, and submit the
offer on behalf of, our client.

Financing pre-approval

Obtaining pre-approval for a home purchase prior to submitting
an offer can greatly strengthen the quality of an offer for our
buyers. Therefore, we offer our clients a pre-approval option on
our website through the ZipRealty Mortgage Center, which is
provided by E-LOAN,
Inc. Clients input all of the required data into the online
form, and the pre-approval process can be completed in a matter
of minutes. Clients can conveniently print out their own
pre-approval letters from
E-LOAN to submit with
offers. Clients can also call
E-LOAN through our
mortgage center for additional assistance.

ZIPAGENT PLATFORM

Our ZipAgent Platform is our proprietary web-based system that
systematically integrates and records all consumer contact
information and website behavior, ZipAgent behavior and
transaction information into a common Oracle-based platform. ZAP
records relevant consumer behavior such as logon frequency and
times, specific homes viewed and printed, searches made by
clients, requested visits to view a home and online offers. The
system also records and organizes all relevant ZipAgent
activities, such as frequency and length of ZipAgent logins,
automatically captures and stores all email communications,
organized by client, and requires ZipAgents to input summary
information about all client phone calls, visits conducted and
offers submitted and accepted.

We use the data collected by ZAP to more effectively manage our
ZipAgents to ensure each is working diligently, productively and
in our clients best interests. The system also
incorporates proprietary CRM tools that allow ZipAgents to
manage their databases of clients. For example, one tool uses
predictive behavior to help our ZipAgents identify those clients
who are likely to need their services in the near term. ZAP also
has an array of real-time management reports which gives our
management detailed visibility into daily business activity.
Finally, ZAP includes automated closing checklists and tools
that allow our ZipAgents and district coordinators who assist
our ZipAgents in the closing process to efficiently handle the
closing of multiple transactions. We believe that ZAP enables
our ZipAgents to be more productive and enhances the level of
service we provide our clients.

ZIPAGENTS

We believe that we are one of the few residential real estate
brokerages that engages its agents as full-time employees rather
than as independent contractors. Independent contractors work
for themselves, not a brokerage, and consequently have a
tremendous degree of independence in how they spend their time,
when they work and how well they service clients. In contrast,
our employee-based model allows us to actively manage and train
our ZipAgents and hold them accountable for their activities and
client service levels. We believe that by actively managing and
training our employee ZipAgents we can both enhance the client
experience and increase ZipAgent productivity.

Compensation structure

We offer our ZipAgents a compensation package that we believe is
attractive compared to that offered by traditional brokerage
firms. We believe that our compensation package leads to a
higher degree of ZipAgent loyalty and a consistently high level
of client service. Our compensation package includes:



Commissions. As is customary in the real estate brokerage
industry, ZipAgents earn a portion of the commissions they
generate for us, which is known as their split. Industry
commission splits vary widely, but frequently range from 70% to
80% to the agent and the balance to the brokerage firm.
Currently, our commission splits to ZipAgents vary from as low
as 35% to as high as 80% of our net revenues, after deducting
certain other items.



Expense reimbursement. All California and other eligible
ZipAgents (including, where applicable, ZipAgents who have met
certain levels of productivity) receive expense reimbursement.
This reimbursement covers many expenses typically related to
their business, such as automobile usage, cell phone usage and
Internet connectivity.



Company-paid marketing expenses. In the traditional
independent contractor model, agents are typically responsible
for covering all of their own marketing expenses, including the
cost of lead generation, advertising and marketing costs
associated with selling homes and production of collateral
materials. In our model, we cover these costs for all of our
ZipAgents.



Benefits. One of the advantages of our employee-based
model for our ZipAgents is that we provide them with a broad
array of benefits that are uncommon in the real estate brokerage
industry, including company-sponsored health, welfare and 401(k)
plans. In addition, ZipAgents have the ability to earn stock
options in connection with annual performance reviews and in
some cases based upon transaction volume.

Recruiting and training

At December 31, 2005, we employed a staff of
21 full-time recruiters who are solely dedicated to
identifying and qualifying prospective ZipAgents. We offer
extensive training programs both for new ZipAgents as they join
us, as well as for existing ZipAgents on an on-going basis.
During 2005, we moved our training facilities from regional to
local offices. New ZipAgents currently receive a week of
orientation and initial training on how to use ZAP in their
local market office. ZipAgents then enter their respective local
markets and are required to complete a series of training
modules with their manager and other local resources

during their first several weeks. On an on-going basis,
ZipAgents are presented with training content through multiple
channels, including webcasts, interactive web training modules
and live presentations during their weekly sales meetings. New
ZipAgents are also frequently paired with seasoned ZipAgents for
their first few transactions to accelerate their training.

CLIENT ACQUISITION

Lead generation

We want our ZipAgents to focus on providing high-quality client
service, rather than finding their next client. Accordingly, we
provide ZipAgents with leads of clients who are actively
searching on our website for properties in their sales
territories. We attract these clients principally by using two
types of paid lead sources. First, we retain hosts of other
websites to provide links to our website. Those hosts are
typically businesses that are lead generators or that are
involved in the real estate or financial services industries.
Second, we actively advertise in key locations on the Web where
consumers gather or conduct searches for real estate
information. We currently have contractual relationships with
over 40 lead sources of either type. In 2005 only two
independent lead sources generated in excess of 10% of our
leads. Homegain, Inc. generated approximately 29% of our leads
and Google represented approximately 12% of our leads during the
year. Homegain competes with us for on-line customer
acquisition. In addition to paid lead sources, in 2005 we
attracted approximately 29% of our leads directly to our
website, which involved no direct acquisition costs.

The majority of our lead source agreements are in the form of
non-exclusive, short-term agreements (six months or less) that
are generally terminable on little or no notice (60 days or
less) and with no penalties. These agreements typically are
priced on a cost-per-click, or CPC, cost-per-lead, or CPL, or
cost-per-impression, or CPM, basis, with a majority being on a
CPC and CPL basis. Under our CPC agreements, we pay a fixed
amount each time a potential client clicks on one of our
advertisements and is directed to our website. Under our CPL
agreements, we pay a fee for each lead we generate from that
source. We define a lead as a client who has registered on our
website, confirmed an email address, searched for homes or owns
a home to be sold in an area where we have operations, and has
been assigned to one of our ZipAgents. Under our CPM agreements,
we are charged a fee each time a potential client views one of
our advertisements.

We have found that localized content is a key to driving
qualified leads to our site. Once a client visits our website,
we are able to track significant information about the client,
including which website and link the consumer clicked on, how
frequently they visit our website, what activities they perform
while on our website and whether they ultimately transact with
us. By using this data, we believe we can optimize our lead
generation expenses based on the most productive sources and
continually refine the ways in which we advertise our services.

PRODUCT DEVELOPMENT AND ENGINEERING

At December 31, 2005, our technology team was comprised of
26 employees, including a product development team, software
engineers, database and data center engineers and a data
acquisition team. Our technology team focuses on enhancing and
improving our existing technology as well as developing new
proprietary tools.

Our technology team is responsible for maintaining property
listings data through our over 36 MLS memberships. In order to
ensure we provide the most comprehensive and timely data
available, we download MLS data seven days a week, and for most
MLSs, multiple times per day. Currently, we provide information
on approximately 580,000 homes in our searchable database in the
markets we serve. To provide our consumers with a more complete
understanding of homes and neighborhoods, we combine data from
the MLSs with additional local information from other data
sources which we license on a non-exclusive basis.

Our product development team is responsible for fulfilling all
product requirements on both our consumer website and the
ZipAgent Platform. This team generally internally releases
software updates approximately once per quarter. As part of our
development process, the product development team works with
users to identify feature enhancements that will provide a
better consumer experience, increase ZipAgent productivity

and enhance management oversight capabilities. Our system is not
dependent on a clients computer configuration, working
with all principal Internet service providers and Internet
browsers. Our system is Java-based and uses commercially
available hardware and proprietary database technology based on
an Oracle platform, making it highly scalable. Our application
server is compliant with relevant industry standards.

We serve our clients from a third party co-location facility
located in Sunnyvale, California, operated by Qwest
Communications. The facility is secured by
around-the-clock guards
and biometric access screening and is equipped with
back-up generators,
redundant HVAC and Internet connectivity. We regularly rotate
back-up tapes to
another location for safekeeping.

REGULATORY MATTERS

The real estate industry is highly regulated. In the conduct of
our business, we must monitor and comply with a wide variety of
applicable laws and regulations of both the government and
private organizations.

Government regulation

The most extensive regulations applicable to our business are at
the state level and are typically overseen by state agencies
dedicated to real estate matters. However, the residential real
estate industry is also regulated by federal and local
authorities.

State regulation. Real estate licensing laws vary from
state to state, but generally all individuals and entities
acting as real estate brokers or salespersons must be licensed
in the state in which they conduct business. A person licensed
as a broker may either work independently or may work for
another broker in the role of an associate broker, conducting
business on behalf of the sponsoring broker. A person licensed
as a salesperson must be affiliated with a broker in order to
engage in licensed real estate brokerage activities. Generally,
a corporation engaged in the real estate brokerage business must
obtain a corporate real estate broker license. In order to
obtain this license, most jurisdictions require that an officer
of the corporation be licensed individually as a real estate
broker in that jurisdiction. If applicable, this officer-broker
is responsible for supervising the licensees and the
corporations real estate brokerage activities within the
state. Real estate licensees, whether they are brokers,
salespersons, individuals or entities, must follow the
states real estate licensing laws and regulations. These
laws and regulations generally prescribe minimum duties and
obligations of these licensees to their clients and the public,
as well as standards for the conduct of business, including
contract and disclosure requirements, record keeping
requirements, requirements for local offices, trust fund
handling, agency representation, advertising regulations and
fair housing requirements. Although payment of rebates or
credits to real estate purchasers of the type we offer are
permitted in most states, some states either do not permit these
rebates or credits, or do not permit them in the form that we
currently provide them. In each of the eleven states and the
District of Columbia where we currently have operations, we have
designated one of our officers as the individually licensed
broker and, where applicable, we hold a corporate real estate
brokers license.

Federal regulation. In addition to state regulations,
there are federal laws and regulations that govern the real
estate brokerage business. The applicable federal regulations
include the Real Estate Settlement Procedures Act of 1974, as
amended, or RESPA, and federal fair housing laws. RESPA, as
applicable to us, is intended to provide for more effective
advance disclosures to home buyers and sellers of settlement
costs and the elimination of kickbacks or referral fees that
tend to increase unnecessarily the costs of certain settlement
services. While RESPA has broad-reaching impact on a variety of
services associated with the purchase or sale of real estate,
including lending, title insurance and settlement services, its
principal application to the real estate brokerage business is
to limit payment of referral fees or the inappropriate splitting
of fees, and to require additional consumer disclosures.
Generally, it is illegal under RESPA to pay or receive a
referral fee or other fee, kickback or anything of value in a
real estate transaction involving a federally related mortgage
loan for the referral of business. RESPA limits the type of
business relationships that we can enter into for acquiring
client leads or otherwise, as well as the referral of clients to
other service providers. RESPA also limits the manner in which
we can provide other services to our customers. Federal fair
housing laws generally

make it illegal to discriminate against protected classes of
individuals in housing or brokerage services. Other federal
regulations protect the privacy rights of consumers, and affect
our opportunities to solicit new clients.

Local regulation. Local regulations also govern the
conduct of the real estate brokerage business. Local regulations
generally require additional disclosures by the parties to a
real estate transaction or their agents, or the receipt of
reports or certifications, often from the local governmental
authority, prior to the closing or settlement of a real estate
transaction.

Federal and state labor regulation. In addition to the
real estate regulations discussed above, we are also subject to
federal and state regulation of our employment practices
including the compensation of ZipAgents. ZipAgents are exempt
from the overtime and minimum wage provisions of the federal
Fair Labor Standards Act because their duties selling
residential real estate and the commission-based method of
compensation are designed to qualify for the outside sales
exemption under the terms of the Fair Labor Standards Act
and the U.S. Department of Labors regulations. The
outside sales exemption is applied on a case-by-case
basis and is considered in light of the specific duties
performed by an individual ZipAgent. Accordingly, as to any
individual ZipAgent, in the event his or her duties become
different than those currently assigned and contemplated, it
might be determined that the exemption is inapplicable. In that
event, we could be subject to penalties and damages including
back pay and attorneys fees for the failure to pay the
individual in accordance with his or her actual duties.

Further, the Department of Labors regulations are subject
to interpretation by the Department of Labor and the courts and
are subject to change. New regulations were promulgated in final
form on April 23, 2004 and went into effect August 23,
2004. Accordingly, there is little precedent or guidance
regarding the interpretation and application of the new
regulations with respect to the outsider sales
exemption nor any assurance how long these regulations
will remain in place. In the event it appears the legal standard
for the outside sales exemption changes, it may be
necessary to modify the ZipAgent compensation structure.

Individual states also sometimes elect to adopt overtime and
minimum wage laws providing greater benefits to employees than
the Fair Labor Standards Act. The ZipAgent job is designed to
qualify for exemption from such laws, to the extent applicable,
in the states in which we currently employ ZipAgents. Like the
federal law, these state laws are applied on a case-by-case
basis considering the duties of specific individuals and are
subject to judicial and agency interpretation and legislative
change. New interpretations or changes in state law, or
expansion of operations to states that do not recognize an
outside sales exemption comparable to the federal
exemption, may require modification of the ZipAgent compensation
structure. In addition, some states, such as California, have
enacted laws concerning the reimbursement of employee expenses,
which caused us to change our compensation practices in 2005. If
we are so required by other state laws, we may need to modify
our compensation structure in such states.

Third-party regulation

In addition to governmental regulations, we are subject to rules
and regulations established by private real estate trade
organizations, including, among others, local MLSs, NAR, state
Associations of
REALTORS®,
and local Associations of
REALTORS®.
The rules and regulations of the various MLSs to which we belong
vary, and specify, among other things, how we as a broker member
can use MLS listing data, including specifying, in some cases,
the use and display of this data on our website.

Additionally, we operate a virtual office website, or VOW, which
is a password-protected website that allows us to show
comprehensive MLS data directly to consumers without their
having to visit an agent. In late 2002, NAR, the dominant trade
organization in the residential real estate industry, adopted a
mandatory policy for NAR-affiliated MLSs regarding the use and
display of MLS listings data on VOWs. Under the NAR policy,
individual MLSs affiliated with NAR, which includes the vast
majority of MLSs in the United States, were required to
implement their own individual VOW policies consistent with
those of NAR, but NAR extended the deadline for the
implementation of its rules at least three times during an
investigation by the antitrust division of the
U.S. Department of Justice, or DOJ, into NARs policy
that dictates how brokers can display other brokers
property listings on their websites. In September 2005, NAR
replaced its VOW policy with an Internet Listings Display, or
ILD, policy containing some of the same or similar features of
its

former VOW policy, and the DOJ responded by immediately filing a
lawsuit in federal court against NAR challenging the ILD policy.
NAR has postponed the deadline for the implementation of its ILD
rules by its member MLSs pending resolution of that lawsuit. We
presently do not know whether or when the NAR rules will be
implemented in their current form or in a revised form, if at
all. Once the individual MLSs implement the ILD policy, the NAR
policy currently provides that member brokerages will have up to
90 days to comply with the policy.

The NAR policy is designed to provide structure to the
individual MLS policies concerning the display of listing
information through the internet, subject to a number of areas
in which the individual MLSs may tailor the policy to meet their
local needs. One NAR policy provision with which the individual
MLSs must adhere, once required to be implemented, is known as
an opt-out. This provision creates a mechanism for
individual brokers to prevent their listings data from being
displayed by competitors on their websites but not by
brick-and-mortar competitors at their offices by other means,
which the DOJ has alleged is a mechanism designed to chill
competition by Internet-based realtors.

A few of the MLSs of which we are a member, as well as at least
one of the state Association of
REALTORS®
of which we are a member, had adopted VOW policies with opt-out
provisions, but, to our knowledge, to date no members or
participants of any of those MLSs have exercised such an opt-out
right. We do not know of any MLSs which have adopted the new ILD
policy with its opt-out provisions. Should any such opt-outs
right be exercised, it could restrict our ability to display
comprehensive MLS home listings data to our consumers, which is
a key part of our business model. Should our ability to display
MLS listings information on our website be significantly
restricted, it may reduce demand for our services and lead to a
decrease in the number of residential real estate transactions
completed by our ZipAgents, as well as increase our costs of
ensuring compliance with such restrictions.

NAR, as well as the state and local Associations of
REALTORS®,
also have codes of ethics, rules and regulations governing the
actions of members in dealings with other members, clients and
the public. We are bound to abide by these codes of ethics,
rules and regulations by virtue of our membership in these
organizations.

COMPETITION

The market for residential real estate brokerage services is
highly fragmented at the national level, with no individual
brokerage holding more than a 5% share, and the 10 largest
brokerages holding less than 10% collectively, according to the
latest REAL Trends information available as of this
writing. However, the eight largest national brands that
brokerages work under through franchise affiliations had
slightly less than a 50% U.S. market share, according to
REAL Trends, providing the potential for significant
national and local influence. We compete with these brokerages
at the local level to represent home buyers or sellers. Some of
those competitors are large national brokerage firms or
franchisors, such as Prudential Financial, Inc., RE/MAX
International Inc. and Cendant Corporation, which owns the
Century 21, Coldwell Banker and ERA franchise brands, a
large corporate relocation business and NRT Incorporated, the
largest brokerage in the United States. NRT Incorporated owns
and operates brokerages that are typically affiliated with one
of the franchise brands owned by Cendant. We are also subject to
competition from local or regional firms, as well as individual
real estate agents. We also compete or may in the future compete
with various online services, such as InterActiveCorp/ IAC and
its LendingTree unit, HouseValues, Inc., HomeGain, Inc.,
Homestore, Inc. and its Realtor.com affiliate, Zillow and Yahoo!
Inc. that also look to attract and service home buyers and
sellers using the Internet. Homestore is affiliated with NAR,
National Association of Home Builders, or NAHB, and a number of
major MLSs, which may provide Homestore with preferred access to
listing information and other competitive advantages. While
these online services companies are intermediaries providing
lead referrals and are not full-service brokerages like us, we
compete with these companies to attract consumers to our
website. There are also a growing number of discount firms that
cater exclusively to clients who are looking for reduced service
levels as well as for sale by owner services.

We believe that the key competitive factors in the residential
real estate segment include the following:



quality of the home data available to clients;



quality of the agents;



level of client responsiveness;



level of commissions charged sellers or incentives provided to
buyers;



local knowledge;



ease of product usability; and



overall client service.

We believe that our Internet-enabled, employee-based model
positions us well relative to our competition to address these
competitive factors in our industry.

INTELLECTUAL PROPERTY

We rely on a combination of trademark, copyright, trade secret
and patent laws in the United States as well as confidentiality
procedures and contractual provisions to protect our proprietary
technology and our brand. We currently have trademarks
registered or pending in the United States for our name and
certain words and phrases that we use in our business. We also
rely on copyright laws to protect computer programs relating to
our website, our proprietary database and ZAP. We have
registered numerous Internet domain names related to our
business in order to protect our proprietary interests, and we
hold a patent issued in the United States that covers certain
processes and methodologies related to transacting residential
real estate on the Internet. We also enter into confidentiality
and invention assignment agreements with our employees and
consultants and confidentiality agreements with other third
parties, and we strictly control access to our proprietary
technology.

From time to time, we may encounter disputes over rights and
obligations concerning intellectual property. Also, the efforts
we have taken to protect our proprietary rights may not be
sufficient or effective. Any significant impairment of our
intellectual property rights could harm our business, our brand
and reputation, or our ability to compete. Also, protecting our
intellectual property rights could be costly and time consuming.

EMPLOYEES

At December 31, 2005, we had 1,556 employees. Of this
total, 1,366 were licensed ZipAgents, 93 were district directors
or field support personnel and 97 were corporate employees. We
consider our employee relations to be good.

EXECUTIVE OFFICERS

The following table sets forth certain information about our
executive officers as of March 10, 2006:

Eric A. Danziger has served as our President, Chief
Executive Officer and a member of our board of directors since
June 2001. Prior to joining us, from February 1998 to June 2001,
Mr. Danziger served as President and Chief Operating
Officer of Carlson Hotels Worldwide, a hotel and resort
management company including the hospitality brands Radisson
Hotels Worldwide, Regent International, and Country Inns and
Suites. From May 1996 to February 1998, Mr. Danziger served
as President and Chief Executive Officer of Starwood Hotels and
Resorts Worldwide, Inc., and from September 1990 to May 1996, he
served as President of Wyndham Hotels and Resorts.

Gary M. Beasley has served as our Executive Vice
President since February 2004 and our Chief Financial Officer
since November 2001. Mr. Beasley previously served as our
Senior Vice President from October 2002 to February 2004 and as
our Vice President from November 2001 to October 2002. Prior to
joining us, from June 1995 to November 2001, Mr. Beasley
served in various executive positions with KSL Recreation
Corporation, a resort and leisure sector company, most recently
as Vice President of Business Development and Acquisitions.
Mr. Beasley holds a Masters of Business Administration
degree from the Stanford University Graduate School of Business
and a Bachelor of Arts degree in economics from Northwestern
University.

William C. Sinclair has served as our Executive Vice
President of Operations and Business Development since August
2005. From September 2002 to August 2005, Mr. Sinclair
serves as our Senior Vice President of Sales and Operations.
Prior to joining us, from October 1998 to September 2002,
Mr. Sinclair served as Executive Vice President and Chief
Operating Officer for the Asia Pacific division of Radisson
Hotels and Resorts Worldwide. From December 1997 to October
1998, Mr. Sinclair served as Vice President of New Business
Development for Promus Hotel Corporation. Mr. Sinclair
holds a Bachelor of Arts degree in business from Washington
State University.

Joseph Patrick Lashinsky has served as our Senior Vice
President of Product Strategy and Development since April 2005.
From February 2000 to April 2005, Mr. Lashinsky served as
our Vice President in a number of marketing, business
development and sales positions. Prior to joining us, from March
1999 to February 2000, Mr. Lashinsky served as Group
Marketing Manager at Del Monte Foods Company. Mr. Lashinsky
holds a Masters of Business Administration degree from the
University of California at Los Angeles and a Bachelor of Arts
degree in political economies of industrialized societies from
the University of California at Berkeley.

Jeffrey G. Wagoner has served as our Senior Vice
President of Sales since August 2005. From April 2004 to August
2005, Mr. Wagoner served as our Vice President and Regional
Manager, Western Region. From October 1998 to April 2004,
Mr. Wagoner served in several management positions at
Wyndham Hotels, including Senior Vice President of Operations
for the North and Central regions of Wyndham Hotels &
Resorts and Summerfield Suites and Senior Vice President of
Wyndham Hotels and Garden Hotels throughout North America.

David A. Rector has served as our Vice President,
Controller and Chief Accounting Officer since May 2004, as our
Vice President and Corporate Controller from October 2002 to May
2004 and as our Corporate Controller from April 2002 to
September 2002. Prior to joining us, from June 1999 to January
2002, Mr. Rector worked in various financial positions for
several companies as a consultant for Resources Connection Inc.,
a consulting firm. Prior to that, he held senior financial
positions at various companies, including commercial real estate
companies Allegiance Realty Group and Fox & Carskadon
Financial Corporation and served as an audit manager at Price
Waterhouse. Mr. Rector is a Certified Public Accountant and
holds a Bachelor of Science degree in business administration
from the University of California at Los Angeles.

Richard H. Roberts has served as our Vice President of
Marketing since August 2005. From September 2002 to July 2005,
Mr. Roberts served as Associate Vice President of Product
for CNET.com, a web site that connects buyers and sellers of
personal technology products. From May 2001 to September 2002,
Mr. Roberts served as Senior Director of Marketing for
Broderbund Software, a producer of consumer software. From
August 1997 to March 2001, Mr. Roberts served as Vice
President of Marketing for Zing.com., a leading

photo e-commerce web
site. Mr. Roberts holds a Masters of Business
Administration degree from the School of Management at Yale
University and a Bachelor of Arts degree in economics from Emory
University.

Karen B. Seto has served as our Vice President, General
Counsel and Secretary since June 2004. From August 2000 to June
2004, Ms. Seto practiced corporate and securities law at
Wilson Sonsini Goodrich & Rosati, P.C., most
recently as Special Counsel. From October 1994 to May 2000,
Ms. Seto was an attorney with Fried, Frank, Harris,
Shriver & Jacobson LLP in Los Angeles. Ms. Seto
holds a Juris Doctor degree from the University of California at
Los Angeles and a Bachelor of Science in Economics degree cum
laude from the Wharton School of the University of
Pennsylvania.

Item 1A.

Risk Factors:

RISK FACTORS

Because of the following factors, as well as other variables
affecting our operating results and financial condition, past
financial performance may not be a reliable indicator of future
performance, and historical trends should not be used to
anticipate results or trends in future periods.

RISKS RELATED TO OUR BUSINESS AND INDUSTRY

We have been profitable in only eight quarters and may
incur losses in the future, and our limited operating history
makes our future financial performance difficult to
assess.

We were formed in January 1999 and therefore have a limited
operating history upon which to evaluate our operations and
future prospects. We have had a history of losses from inception
through the first half of 2003 and at December 31, 2005 had
an accumulated deficit of $31.7 million. While we were
profitable in the third and fourth quarters of 2003, the second,
third and fourth quarters of 2004 and the first, third and
fourth quarters of 2005, we may not be profitable in future
quarters or on an annual basis. While we experienced a net loss
in the second quarter of 2005 as a result of a one-time charge
relating to the settlement of a threatened class action lawsuit,
we would have been profitable excluding the effect of this
settlement.

Our business model has evolved, and we have only recently
achieved significant revenues. We may incur additional expenses
with the expectation that our revenues will grow in the future,
which may not occur. As a result, we could experience budgeting
and cash flow management problems, unexpected fluctuations in
our results of operations and other difficulties, any of which
could harm our ability to achieve or maintain profitability,
increase the volatility of the market price of our common stock
or harm our ability to raise additional capital. Additionally,
as a newly public company we must work towards compliance with
the requirements of the Securities and Exchange Commission,
NASDAQ and the Sarbanes-Oxley Act of 2002 as those requirements
become applicable to us, and we may incur costs in connection
with that effort that are significantly higher than anticipated,
which could negatively impact our profitability.

We expect that we will continue to increase our expenses,
including marketing and business development expenses and
expenses incurred as a result of increasing the number of agents
we employ. As we grow our business in existing markets and
expand to new markets, we cannot guarantee our business
strategies will be successful or that our revenues will ever
increase sufficiently to achieve and maintain profitability on a
quarterly or annual basis.

Our business model requires access to real estate listing
services provided by third parties that we do not control, and
the demand for our services may be reduced if our ability to
display listings on our website is restricted.

A key component of our business model is that through our
website we offer clients access to, and the ability to search,
real estate listings posted on the MLSs in the markets we serve.
Most large metropolitan areas in the United States have at least
one MLS, though there is no national MLS. The homes in each MLS
are listed voluntarily by its members, who are licensed real
estate brokers. The information distributed in an MLS allows
brokers to cooperate in the identification of buyers for listed
properties.

If our access to one or more MLS databases were restricted or
terminated, our service could be adversely affected and our
business may be harmed. Because participation in an MLS is
voluntary, a broker or group of brokers may decline to post
their listings to the existing MLS and instead create a new
proprietary real estate listing service. If a broker or group of
brokers created a separate real estate listing database, we may
be unable to obtain access to that private listing service on
commercially reasonable terms, if at all. As a result, the
percentage of available real estate listings that our clients
would be able to search using our website would be reduced,
perhaps significantly, thereby making our services less
attractive to potential clients.

Additionally, we operate a virtual office website, or VOW, which
is a password protected website that allows us to show
comprehensive MLS data directly to consumers without their
having to visit an agent. In late 2002, the National Association
of Realtors, or NAR, the dominant trade organization in the
residential real estate industry, adopted a mandatory policy for
NAR-affiliated MLSs regarding the use and display of MLS
listings data on VOWs. Under the NAR policy, individual MLSs
affiliated with NAR, which includes the vast majority of MLSs in
the United States, were required to implement their own
individual VOW policies consistent with the NAR, but NAR
extended the deadline for the implementation of its rules at
least three times during an investigation by the antitrust
division of the U.S. Department of Justice, or DOJ, into
NARs policy that dictates how brokers can display other
brokers property listings on their websites. In September
2005, NAR replaced its VOW policy with an Internet Listings
Display, or ILD, policy containing some of the same or similar
features of its former VOW policy, and the DOJ responded by
immediately filing a lawsuit in federal court against NAR
challenging the ILD policy. NAR has postponed the deadline for
the implementation of its ILD rules by its member MLSs pending
resolution of that lawsuit. We presently do not know whether or
when the NAR rules will be implemented in their current form or
in a revised form, if at all. Once the individual MLSs implement
the ILD policy, the NAR policy currently provides that member
brokerages will have up to 90 days to comply with the
policy.

The NAR policy is designed to provide structure to the
individual MLS policies concerning the display of listing
information through the internet, subject to a number of areas
in which the individual MLSs may tailor the policy to meet their
local needs. One NAR policy provision with which the individual
MLSs must adhere, once required to be implemented, is known as
an opt-out. This provision creates a mechanism for
individual brokers to prevent their listings data from being
displayed by competitors on their websites but not by
brick-and-mortar competitors at their offices by other means,
which the DOJ has alleged is a mechanism designed to chill
competition by internet-based realtors.

A few of the MLSs of which we are a member, as well as at least
one of the state Association of
REALTORS®
of which we are a member, had adopted VOW policies with opt-out
provisions, but, to our knowledge, to date no members or
participants of any of those MLSs have exercised such an opt-out
right. We do not know of any MLSs which have adopted the new ILD
policy with its opt-out provisions. Should any such opt-outs
right be exercised, it could restrict our ability to display
comprehensive MLS home listings data to our consumers, which is
a key part of our business model. Should our ability to display
MLS listings information on our website be significantly
restricted, it may reduce demand for our services and lead to a
decrease in the number of residential real estate transactions
completed by our ZipAgents, as well as increase our costs of
ensuring compliance with such restrictions.

Our business could be harmed by transitions in the real
estate markets and economic events that are out of our control
and may be difficult to predict.

The success of our business depends in part on the health of the
residential real estate market, which traditionally has been
subject to cyclical economic swings. The purchase of residential
real estate is a significant transaction for most consumers, and
one which can be delayed or terminated based on the availability
of discretionary income. Economic slowdown or recession, rising
interest rates, adverse tax policies, lower availability of
credit, increased unemployment, lower consumer confidence, lower
wage and salary levels, war or terrorist attacks, natural
disaster, oil price spikes or the public perception that any of
these events may occur, could adversely affect the demand for
residential real estate and would harm our business. Also, if
interest rates increase significantly, homeowners ability
to purchase a new home or a higher priced home may be reduced as
higher monthly payments would make housing less affordable. In
addition, these conditions

could lead to a decline in new listings, transaction volume and
sales prices, any of which would harm our operating results.

Since early September of 2005 we have experienced a significant
increase in the available inventory of homes for sale in many of
our markets, as well as an increase in the amount of time
listings are taking to sell. Pricing increases have also slowed,
and some markets have shown declines in median selling prices
over this period. Nationally, sales of existing homes fell 5.2%
year-over-year in January 2006 to a seasonally adjusted
annual rate of 6.6 million, the lowest in nearly two years. This
represented the fifth month in a row that sales have declined.
In our opinion, these data points suggest the housing market is
in a period of transition, with more power shifting to buyers
from sellers, which may impair our ability to grow the Company
and our agent productivity.

Our business model is new and unproven, and we cannot
guarantee our future success.

Our Internet-enabled residential real estate brokerage service
is a relatively new and unproven business model. Our business
model differs significantly from that of a traditional real
estate brokerage firm in several ways, including our heavy
reliance on the Internet and technology and our employee agent
model. The success of our business model depends on our ability
to achieve higher transaction volumes at an overall lower cost
per transaction in order to offset the costs associated with our
technology, employee benefits, marketing and advertising
expenses and discounts and rebates. If we are unable to
efficiently acquire clients and maintain agent productivity in
excess of industry averages, our ZipAgents may close fewer
transactions and our net revenues could suffer as a result.
Also, given that our agent employee model is uncommon in the
real estate industry, our compensation structure could be
subject to legal challenge, such as the litigation discussed in
Part I, Item 3 of this report. In addition, our agents
generally earn a lower per transaction commission than a
traditional independent contractor agent. If we are unsuccessful
in providing our agents with more opportunities to close
transactions than under the traditional model, our ability to
hire and retain qualified real estate agents would be harmed,
which would in turn significantly harm our business.

If we fail to recruit, hire and retain qualified agents,
we may be unable to service our clients and our growth could be
impaired.

Our business requires us to hire employees who are licensed real
estate agents, and our strategy is based on consistently and
rapidly growing our team of ZipAgents. Competition for qualified
agents is intense, particularly in the markets in which we
compete, and retention is an industry-wide issue. While there
are many licensed real estate agents in our markets and
throughout the country, historically we have had difficulties in
recruiting and retaining properly qualified licensed agents due
particularly to agent discomfort with using technology and being
actively managed by an employer. In addition, our lower per
transaction agent commission model may be unattractive to
certain higher performing agents. If we are unable to recruit,
train and retain a sufficient number of qualified licensed real
estate agents, we may be unable to service our clients properly
and grow our business.

Historically we have experienced a high degree of agent
turnover, most of which occurs in the first few months after
commencing employment. This turnover has required us to expend a
substantial amount of time and money to replace agents who have
left as we have been growing our business. If this situation
worsens, our rate of expansion into new markets could be slowed
and we will continue to employ a significantly higher number of
new agents with less experience operating in our business model,
which could cause us to be less effective at expanding our
market share in our existing markets and entering new markets.

Furthermore, we rely on federal and state exemptions from
minimum wage and fair labor standards laws for our ZipAgents,
who are compensated solely through commissions. Such exemptions
may not continue to be available, or we may not qualify for such
exemptions, which could subject us to penalties and damages for
non-compliance. Also, some states, such as California, have
enacted laws requiring the reimbursement of employee expenses,
which caused us to change our compensation practices in 2005. If
similar exemptions are not available in states where we desire
to expand our operations or if they cease to be available in the
states where we currently operate, or if we are so required by
other state laws, we may need to modify our agent

compensation structure in such states, which could cause our
compensation practices to be less attractive to agents or more
expensive to the Company.

Our failure to effectively manage the growth of our
ZipAgents and our information and control systems could
adversely affect our ability to service our clients.

As our operations have expanded, we have experienced rapid
growth in our headcount from 1,059 total employees, including
914 ZipAgents, at December 31, 2004 to 1,556 total
employees, including 1,366 ZipAgents, at December 31, 2005.
We expect to continue to increase headcount in the future,
particularly the number of ZipAgents. Our rapid growth has
demanded, and will continue to demand, substantial resources and
attention from our management. We will need to continue to hire
additional qualified agents and improve and maintain our
technology to properly manage our growth. If we do not
effectively manage our growth, our client service and
responsiveness could suffer and our costs could increase, which
could negatively affect our brand and operating results.

As we grow, our success will depend on our ability to continue
to implement and improve our operational, financial and
management information and control systems on a timely basis,
together with maintaining effective cost controls. This ability
is particularly critical as we implement new systems and
controls to help us comply with the more stringent requirements
of being a public company, including the requirements of the
Sarbanes-Oxley Act of 2002, which require management to evaluate
and assess the effectiveness of our internal control over
financial reporting and our disclosure controls and procedures.
Effective internal control over financial reporting is required
by law and is necessary for us to provide reliable financial
reports and effectively prevent fraud. Effective disclosure
controls and procedures are required by law and are necessary
for us to file complete, accurate and timely reports under the
Securities Exchange Act of 1934. Any inability to provide
reliable financial reports or prevent fraud or to file complete,
accurate and timely reports under the Securities Exchange Act
could harm our business, harm our reputation or result in a
decline in or stock price. We are continuing to evaluate and,
where appropriate, enhance our systems, procedures and internal
controls. If our systems, procedures or controls are not
adequate to support our operations and reliable, accurate and
timely financial and other reporting, we may not be able to
successfully satisfy regulatory and investor scrutiny, offer our
services and implement our business plan.

Our operating results are subject to seasonality and vary
significantly among quarters during each calendar year, making
meaningful comparisons of successive quarters difficult.

The residential real estate market traditionally has experienced
seasonality, with a peak in the spring and summer seasons and a
decrease in activity during the fall and winter seasons.
Revenues in each quarter are significantly affected by activity
during the prior quarter, given the typical 30- to
45-day time lag between
contract execution and closing. Historically, this seasonality
has caused our revenues, operating income, net income and cash
flow from operating activities to be lower in the first and
fourth quarters and higher in the second and third quarters of
each year.

We expect our revenues to continue to be subject to these
seasonal fluctuations, which, combined with our recent growth,
make it difficult to compare successive quarters.

Interest rates have been at historic lows for the past
several years, and increases in interest rates have the
potential to negatively impact the housing market.

When interest rates rise, all other things being equal, housing
becomes less affordable, since at a given income level people
cannot qualify to borrow as much principal, or given a fixed
principal amount they will be faced with higher monthly
payments. This result may mean that fewer people will be able to
afford homes at prevailing prices, potentially leading to fewer
transactions or reductions in home prices in certain regions,
depending also on the relevant supply-demand dynamics of those
markets. Since we operate in only 16 markets around the country,
it is possible that we could experience a more pronounced impact
than we would experience if our operations were more
diversified. Should we experience softening in our markets and
not be able to offset the potential negative market influences
on price and volume by increasing our transaction volume through
market share growth, our financial results could be negatively
impacted.

If consumers do not continue to use the Internet as a tool
in their residential real estate buying or selling process, we
may be unable to attract new clients and our growth and
financial results may suffer.

We rely substantially on our website and web-based marketing for
our client lead generation. As the residential real estate
business has traditionally been characterized by personal,
face-to-face
relationships between buyers and sellers and their agents, our
success will depend to a certain extent on the willingness of
consumers to increase their use of online services in the real
estate sales and purchasing process. In addition, our success
will depend on consumers visiting our website early in their
selling or buying process so that we can interface with
potential clients before they have engaged a real estate agent
to represent them in their transactions. If we are unable to
convince visitors to our website to transact business with us,
our ZipAgents will have fewer opportunities to represent clients
in residential real estate transactions and our net revenues
could suffer.

Our success depends in part on our ability to successfully
expand into additional real estate markets.

We currently operate in 16 markets, including 14 of the 25 most
populous U.S. metropolitan statistical areas. A part of our
business strategy is to grow our business by entering into
additional real estate markets and, to this end, we commenced
operations in Las Vegas in April 2005, in Houston in June 2005,
in Miami, Florida in October 2005 and in Tampa, Florida, in
February 2006. Key elements of this expansion include our
ability to identify strategically attractive real estate markets
and to successfully establish our brand in those markets. We
consider many factors when selecting a new market to enter,
including:



the economic conditions and demographics of a market;



the general prices of real estate in a market;



Internet use in a market;



competition within a market from local and national brokerage
firms;



rules and regulations governing a market;



the ability and capacity of our organization to manage expansion
into additional geographic areas, additional headcount and
increased organizational complexity;



the existence of local MLSs; and



state laws governing cash rebates and other regulatory
restrictions.

Before opening Las Vegas we had not entered a new geographic
market since July 2000 and have limited experience expanding
into and operating in multiple markets, managing multiple sales
regions or addressing the factors described above. In addition,
this expansion could involve significant initial
start-up costs. We
expect that significant revenues from new markets will be
achieved, if ever, only after we have been operating

in that market for some time and begun to build market awareness
of our services. As a result, geographic expansion is likely to
significantly increase our expenses and cause fluctuations in
our operating results. In addition, if we are unable to
successfully penetrate these new markets, we may continue to
incur costs without achieving the expected revenues, which would
harm our financial condition and results of operations.

Unless we develop, maintain and protect a strong brand
identity, our business may not grow and our financial results
may suffer.

We believe a strong brand is a competitive advantage in the
residential real estate industry because of the fragmentation of
the market and the large number of agents and brokers available
to the consumer. Because our brand is relatively new, we
currently do not have strong brand identity. We believe that
establishing and maintaining brand identity and brand loyalty is
critical to attracting new clients. In order to attract and
retain both clients and employees, and respond to competitive
pressures, we expect to increase our marketing and business
development expenditures to develop, maintain and enhance our
brand in the future.

We plan to continue conducting and refining online, print and
direct mail advertising and possibly to test and conduct radio,
outdoor and/or television advertising campaigns. We plan to
increase our online advertising expenditures in the near future
while maintaining our offline advertising expenditures at
current levels. While we intend to enhance our marketing and
advertising activities in order to attract and retain both
clients and employees, these activities may not have a material
positive impact on our brand identity. In addition, developing
our brand will depend on our ability to provide a high-quality
consumer experience and high quality service, which we may not
do successfully. If we are unable to develop, maintain and
enhance our brand, our ability to attract new clients and
employees or successfully expand our operations will be harmed.

We have numerous competitors, many of which have valuable
industry relationships and access to greater resources than we
do.

The residential real estate market is highly fragmented, and we
have numerous competitors, many of which have greater name
recognition, longer operating histories, larger client bases,
and significantly greater financial, technical and marketing
resources than we do. Some of those competitors are large
national brokerage firms or franchisors, such as Prudential
Financial, Inc., RE/ MAX International Inc. and Cendant
Corporation, which owns the Century 21, Coldwell Banker and
ERA franchise brands, a large corporate relocation business and
NRT Incorporated, the largest brokerage in the United States.
NRT owns and operates brokerages that are typically affiliated
with one of the franchise brands owned by Cendant. We are also
subject to competition from local or regional firms, as well as
individual real estate agents. We also compete or may in the
future compete with various online services, such as
InterActiveCorp and its LendingTree unit, HouseValues, Inc.,
HomeGain, Inc., Homestore, Inc. and its Realtor.com affiliate,
Zillow and Yahoo! Inc. that also look to attract and monetize
home buyers and sellers using the Internet. Homestore is
affiliated with NAR, the National Association of Home Builders,
or NAHB, and a number of major MLSs, which may provide Homestore
with preferred access to listing information and other
competitive advantages. In addition, our technology-focused
business model is a relatively new approach to the residential
real estate market and many consumers may be hesitant to choose
us over more established brokerage firms employing traditional
techniques.

Some of our competitors are able to undertake more extensive
marketing campaigns, make more attractive offers to potential
agents and clients and respond more quickly to new or emerging
technologies. Over the past several years there has been a slow
but steady decline in average commissions charged in the real
estate brokerage industry, with the average commission
percentage decreasing from 5.44% in 2000 to 5.08% in 2004
according to REAL Trends. Some of our competitors with
greater resources may be able to better withstand the short- or
long-term financial effects of this trend. In addition, the
barriers to entry to providing an Internet-enabled real estate
service are low, making it possible for current or new
competitors to adopt certain aspects of our business model,
including offering comprehensive MLS data to clients via the
Internet, thereby reducing our competitive advantage. We may not
be able to compete successfully for clients and agents, and
increased competition could result in price reductions, reduced
margins or loss of market share, any of which would harm our
business, operating results and financial condition.

Changes in federal and state real estate laws and
regulations, and rules of industry organizations such as the
National Association of
REALTORS®,
could adversely affect our business.

The real estate industry is heavily regulated in the United
States, including regulation under the Fair Housing Act, the
Real Estate Settlement Procedures Act, state and local licensing
laws and regulations and federal and state advertising laws. In
addition to existing laws and regulations, states and industry
participants and regulatory organizations could enact
legislation, regulatory or other policies in the future, which
could restrict our activities or significantly increase our
compliance costs. Moreover, the provision of real estate
services over the Internet is a new and evolving business, and
legislators, regulators and industry participants may advocate
additional legislative or regulatory initiatives governing the
conduct of our business. If existing laws or regulations are
amended or new laws or regulations are adopted, we may need to
comply with additional legal requirements and incur significant
compliance costs, or we could be precluded from certain
activities. Because we operate through our website, state and
local governments other than where the subject property is
located may attempt to regulate our activities, which could
significantly increase our compliance costs and limit certain of
our activities. In addition, industry organizations, such as NAR
and other state and local organizations, can impose standards or
other rules affecting the manner in which we conduct our
business. As mentioned above, NAR has adopted rules that, if
implemented, could result in a reduction in the number of home
listings that could be viewed on our website. NAR has extended
the deadline for the implementation of its rules pending the
resolution of a lawsuit filed in federal court by the antitrust
division of the U.S. Department of Justice challenging,
among other things, NARs proposed ILD policy that dictates
how brokers can display other brokers property listings on
their websites. We presently do not know whether or when the NAR
rules will be implemented in their current form or in a revised
form, if at all. The implementation of the rules will not limit
our access to listing information, but could limit the display
of listing information to our clients through our website in the
manner we currently utilize, as well as increase our costs of
ensuring compliance with such rules. Any significant lobbying or
related activities, either of governmental bodies or industry
organizations, required to respond to current or new initiatives
in connection with our business could substantially increase our
operating costs and harm our business.

We derive a significant portion of our leads through third
parties, and if any of our significant lead generation
relationships are terminated, impaired or become more expensive,
our ability to attract new clients and grow our business may be
adversely affected.

We generate leads for our ZipAgents through many sources,
including leads from third parties with which we have only
non-exclusive, short-term agreements that are generally
terminable on little or no notice and with no penalties. Our
largest third-party lead source, Homegain, Inc., which competes
with us for online customer acquisition, generated approximately
29% and 21% of our leads during 2005 and 2004, respectively. In
addition, during the third quarter of 2004 our exclusive
co-branded relationship which we had in four markets with one
third-party lead source, Yahoo! Inc., ended, effective
July 31, 2004. Leads from this source accounted for
approximately 8% of our leads and approximately 8% of our net
revenues during 2004. These leads were inexpensive relative to
those generated from competing sources, although they also were
characterized by a lower conversion rate than is typical from
our other sources. As a result, our lead replacement strategy
delivered fewer leads to the agents in the areas impacted by the
termination of the Yahoo! co-branded relationship but with those
leads characterized by what we believe to be higher conversion
potential based upon historical experience. Should this
replacement strategy not be successful, or any of our other lead
generation relationships become materially more expensive such
that we could not obtain substitute sources on acceptable terms,
our ability to attract new clients and grow our business may be
impaired. Our business may also be impaired to the extent that
state laws or NAR or MLS regulations make it more difficult or
expensive for lead generators to provide us with sufficient
leads.

Our ability to expand our business may be limited by state
laws governing cash rebates to home buyers.

A significant component of our value proposition to our home
buyer clients is a cash rebate provided to the buyer at closing.
Currently, our clients who are home buyers represent a
substantial majority of our business and revenues. Certain
states, such as Alaska, Kansas, Louisiana, Mississippi, New
Jersey, Oklahoma,

Oregon and Tennessee, may presently prohibit sharing any
commissions with, or providing rebates to, clients who are not
licensed real estate agents. In addition, other states may limit
or restrict our cash rebate program as currently structured,
including Missouri and New York. Should we decide to expand into
any of these states, we may have to adjust our pricing structure
or refrain from offering rebates to buyers in these states.
Moreover, we cannot predict whether alternative approaches will
be cost effective or easily marketable to prospective clients.
The failure to enter into these markets, or others that adopt
similar restrictions, or to successfully attract clients in
these markets, could harm our business.

We may be unable to integrate our technology with each MLS
on a cost-effective basis, which may harm our operating results
and adversely affect our ability to service clients.

Each MLS is operated independently and is run on its own
technology platform. As a result, we must constantly modify our
technology to successfully interact with each independent MLS in
order to maintain access to that MLSs home listings
information. In addition, when a new MLS is created, we must
customize our technology to work with that new system. These
activities require constant attention and significant resources.
We may be unable to successfully interoperate with the MLSs
without significantly increasing our engineering costs, which
would increase our operating expenses without a related increase
in net revenues and cause our operating results to suffer. We
may also be unable to interoperate with the MLSs at all, which
may adversely affect the demand for our services.

If we fail to comply with real estate brokerage laws and
regulations, we may incur significant financial penalties or
lose our license to operate.

Due to the geographic scope of our operations and the nature of
the real estate services we perform, we are subject to numerous
federal, state and local laws and regulations. For example, we
are required to maintain real estate brokerage licenses in each
state in which we operate and to designate individual licensed
brokers of record. In some states, these licenses are personal
to the broker. If we fail to maintain our licenses, lose the
services of our designated broker of record or conduct brokerage
activities without a license, we may be required to pay fines or
return commissions received, our licenses may be suspended or we
may be subject to other civil and/or criminal penalties. As we
expand into new markets, we will need to obtain and maintain the
required brokerage licenses and comply with the applicable laws
and regulations of these markets, which may be different from
those to which we are accustomed, may be difficult to obtain and
will increase our compliance costs. In addition, because the
size and scope of real estate sales transactions have increased
significantly during the past several years, both the difficulty
and cost of compliance with the numerous state licensing regimes
and possible losses resulting from non-compliance have
increased. Our failure to comply with applicable laws and
regulations, the possible loss of real estate brokerage licenses
or litigation by government agencies or affected clients may
have a material adverse effect on our business, financial
condition and operating results, and may limit our ability to
expand into new markets.

We may have liabilities in connection with real estate
brokerage activities.

As a licensed real estate broker, we and our licensed employees
are subject to statutory due diligence, disclosure and
standard-of-care
obligations. In the ordinary course of business we and our
employees are subject to litigation from parties involved in
transactions for alleged violations of these obligations. We
self-insure some of this risk and, as we expand our business to
include larger deals, we may not be able to obtain third party
insurance on these larger deals with attractive terms. In
addition, we may be required to indemnify our employees who
become subject to litigation arising out of our business
activities, including for claims related to the negligence of
those employees. An adverse outcome in any such litigation could
negatively impact our reputation and harm our business.

We may be subject to liability for the Internet content
that we publish.

As a publisher of online content, we face potential liability
for negligence, copyright, patent or trademark infringement, or
other claims based on the nature and content of the material
that we publish or distribute. Such claims may include the
posting of confidential data, erroneous listings or listing
information and the

erroneous removal of listings. These types of claims have been
brought successfully against the providers of online services in
the past and could be brought against us or others in our
industry. In addition, we may face liability if a MLS member or
participant utilizes an opt-out provision, as previously
discussed, and we fail to comply with that requirement. These
claims, whether or not successful, could harm our reputation,
business and financial condition. Although we carry general
liability insurance, our insurance may not cover claims of these
types or may be inadequate to protect us for all liability that
we may incur.

We monitor and evaluate the use of our website by our
registered users, which could raise privacy concerns.

Visitors to our website that register with us receive access to
home listing and related information that we do not make
available to unregistered users. As part of the registration
process, our registered users consent to our use of information
we gather from their use of our website, such as the geographic
areas in which they search for homes, the price range of homes
they view, their activities while on our website and other
similar information. They also provide us with personal
information such as telephone numbers and email addresses. While
our registered users consent to our internal use of this
information, if we were to use this information outside the
scope of their consent or otherwise fail to keep this
information confidential from third parties, including our
former agents, we may be subject to legal claims or government
action and our reputation and business could be harmed. While we
do not share website use and other personal information with any
third parties, except with our clients consent to third
parties involved in the transaction process, concern among
consumers regarding our use of personal information gathered
from visitors to our website could cause them not to register
with us. This would reduce the number of leads we derive from
our website. Because our website is our primary client
acquisition tool, any resistance by consumers to register on our
website would harm our business and results of operations, and
could cause us to alter our business practices or incur
significant expenses to educate consumers regarding the use we
make of information.

We may need to change the manner in which we conduct our
business if government regulation of the Internet
increases.

The adoption or modification of laws or regulations relating to
the Internet could adversely affect the manner in which we
currently conduct our business. In addition, the growth and
development of the market for online commerce may lead to more
stringent consumer protection laws that may impose additional
burdens on us. Laws and regulations directly applicable to
communications or commerce over the Internet are becoming more
prevalent. For example, both the U.S. government and the
State of California have enacted Internet laws regarding privacy
and sharing of customer information with third parties. Laws
applicable to the Internet remain largely unsettled, even in
areas where there has been some legislative action. It may take
years to determine whether and how existing laws such as those
governing intellectual property, privacy, libel and taxation
apply to the Internet.

In addition, because each state in which we do business requires
us to be a licensed real estate broker, and residents of states
in which we do not do business could potentially access our
website, changes in Internet regulation could lead to situations
in which we are considered to operate or do
business in such states. This could result in potential
claims or regulatory action.

If we are required to comply with new regulations or new
interpretations of existing regulations, we may not be able to
differentiate our services from traditional competitors and may
not attract a sufficient number of clients for our business to
be successful.

Our reputation and client and agent service offerings may
be harmed by system failures and computer viruses.

The performance and reliability of our technology infrastructure
is critical to our reputation and ability to attract and retain
clients and agents. Our network infrastructure is currently
co-located at a single facility in Sunnyvale, California and we
do not currently operate a
back-up facility. As a
result, any system failure or service outage at this primary
facility would result in a loss of service for the duration of
the failure or outage.

Any system error or failure, or a sudden and significant
increase in traffic, may significantly delay response times or
even cause our system to fail resulting in the unavailability of
our Internet platform. For example, in 2005 we experienced an
unscheduled outage that lasted approximately 12 hours.
During this period our clients and prospective clients were
unable to access our website or receive notifications of new
listings. While we have taken measures to prevent unscheduled
outages, outages may occur in the future. In addition, our
systems and operations are vulnerable to interruption or
malfunction due to certain events beyond our control, including
natural disasters, such as earthquakes, fire and flood, power
loss, telecommunication failures, break-ins, sabotage, computer
viruses, intentional acts of vandalism and similar events. Our
network infrastructure is located in the San Francisco Bay
area, which is susceptible to earthquakes and has, in the past,
experienced power shortages and outages, any of which could
result in system failures and service outages. We may not be
able to expand our network infrastructure, either on our own or
through use of third party hosting systems or service providers,
on a timely basis sufficient to meet demand. Any interruption,
delay or system failure could result in client and financial
losses, litigation or other consumer claims and damage to our
reputation.

Our business is geographically concentrated, which makes
us more susceptible to business interruption and financial loss
due to natural disasters, inclement weather, economic or market
conditions or other regional events outside of our
control.

Presently, our business is conducted principally in a few states
in the western United States, especially California, and along
the eastern seaboard. For example, we derived approximately 52%
of our revenues in the year ended December 31, 2005 in the
state of California. In addition, our servers and other
technology infrastructure are located principally in the state
of California. Our geographic concentration makes us as a whole
more vulnerable to the effects of regional disasters in these
areas, such as earthquakes, harsh weather, economic or market
conditions or other events outside of our control. These events
could cause us to sustain a business interruption or other
financial loss that would be greater than if our business were
more dispersed geographically.

Our intellectual property rights, including existing and future
patents, trademarks, trade secrets, and copyrights, are and will
continue to be valuable and important assets of our business. We
believe that our proprietary ZAP technology and ZipNotify, as
well as our ability to interoperate with multiple MLSs and our
other technologies and business practices, are competitive
advantages and that any duplication by competitors would harm
our business. We have taken measures to protect our intellectual
property, but these measures may not be sufficient or effective.
For example, we seek to avoid disclosure of our intellectual
property by requiring employees and consultants with access to
our proprietary information to execute confidentiality
agreements. We also seek to maintain certain intellectual
property as trade secrets. Intellectual property laws and
contractual restrictions may not prevent misappropriation of our
intellectual property or deter others from developing similar
technologies. In addition, others may develop technologies that
are similar or superior to our technology, including our
patented technology. Any significant impairment of our
intellectual property rights could harm our business.

We may in the future be subject to intellectual property
rights disputes, which could divert management attention, be
costly to defend and require us to limit our service
offerings.

Our business depends on the protection and utilization of our
intellectual property. Other companies may develop or acquire
intellectual property rights that could prevent, limit or
interfere with our ability to provide our products and services.
One or more of these companies, which could include our
competitors, could make claims alleging infringement of their
intellectual property rights. Any intellectual property claims,
with or without merit, could be time-consuming and expensive to
litigate or settle and could significantly divert management
resources and attention.

Our technologies may not be able to withstand any third-party
claims or rights against their use. If we were unable to
successfully defend against such claims, we may have to:



pay damages;



stop using the technology found to be in violation of a third
partys rights;



seek a license for the infringing technology; or



develop alternative non-infringing technology.

If we have to obtain a license for the infringing technology, it
may not be available on reasonable terms, if at all. Developing
alternative non-infringing technology could require significant
effort and expense. If we cannot license or develop alternative
technology for the infringing aspects of our business, we may be
forced to limit our product and service offerings. Any of these
results could reduce our ability to compete effectively, and
harm our business and results of operations.

If we fail to attract and retain our key personnel, our
ability to meet our business goals will be impaired and our
financial condition and results of operations will
suffer.

The loss of the services of one or more of our key personnel
could seriously harm our business. In particular, our success
depends on the continued contributions of Eric A. Danziger, our
President and Chief Executive Officer, and other senior level
sales, operations, marketing, technology and financial officers.
Our business plan was developed in large part by our senior
level officers and its implementation requires their skills and
knowledge. None of our officers or key employees has an
employment agreement, and their employment is at will. We do not
have key person life insurance policies covering any
of our executives.

We intend to evaluate acquisitions or investments in
complementary technologies and businesses and we may not realize
the anticipated benefits from, and may have to pay substantial
costs related to, any acquisitions or investments that we
undertake.

As part of our business strategy, we plan to evaluate
acquisitions of, or investments in, complementary technologies
and businesses. We may be unable to identify suitable
acquisition candidates in the future or be able to make these
acquisitions on a commercially reasonable basis, or at all. If
we complete an acquisition or investment, we may not realize the
benefits we expect to derive from the transaction. Any future
acquisitions and investments would have several risks, including:

potentially dilutive issuances of equity securities or the
incurrence of debt or contingent liabilities;



expenses related to amortization of intangible assets;



risks associated with operating a business or in a market in
which we have little or no prior experience;



potential write offs of acquired assets;



loss of key employees of acquired businesses; and



our inability to recover the costs of acquisitions or
investments.

Accounting for employee stock options using the fair value
method, could significantly reduce our net income in future
periods.

In December 2004, the FASB issued its final standard on
accounting for share-based payments, SFAS 123R (revised
2004), that requires companies to expense the value of employee
stock options and similar awards. In April 2005, the Securities
and Exchange Commission amended the compliance dates and,

accordingly, we will be required to record an expense for our
stock-based compensation plans using the fair value method
beginning on January 1, 2006. This expense will exceed the
expense we currently record for our stock-based compensation
plans and correspondingly reduce our net income in future
periods.

The value of our services could be diminished if anti-spam
software filters out an increasing portion of the emails we
send.

Our ZAP system includes a feature that sends out personalized
email messages to our registered users on behalf of our agents.
Given the volume of these messages, anti-spam software used by
Internet service providers and personal computer users sometimes
treats these messages incorrectly as unsolicited email, or
spam, and filters them out. If this problem becomes
more pervasive, the value of this aspect of our marketing and
communication approach could be diminished, which could harm our
business.

Because our marketing relationship with E-LOAN represents
a source of revenue for us and funding for our clients, we could
be harmed if this relationship became impaired.

We receive revenues from our marketing relationship with E-LOAN,
Inc., which provides the ZipRealty Mortgage Center on our
website and pays us a flat monthly fee that is established on a
periodic basis (representing less than 3% of our revenues during
fiscal year 2005). E-LOAN was acquired by Popular, Inc. in late
2005. If our marketing relationship with E-LOAN became impaired,
we could lose a source of marketing revenue that we may not be
able to readily replace, and our clients could have a more
difficult time obtaining financing, which could negatively
impact our transaction revenues.

OTHER RISKS RELATED TO OUR STOCK PRICE

Our stock price may be volatile.

The trading price of our common stock may fluctuate widely,
depending upon many factors, some of which are beyond our
control. These factors include, among others, the risks
identified above and the following:



variations in our quarterly results of operations;



announcements by us or our competitors or lead source providers;



the relatively low level of public float and average daily
trading volumes of our common stock;



changes in estimates of our performance or recommendations, or
termination of coverage by securities analysts;



inability to meet quarterly or yearly estimates or targets of
our performance;



the hiring or departure of key personnel, including agents or
groups of agents or key executives;



changes in our reputation;



acquisitions or strategic alliances involving us or our
competitors;



changes in the legal and regulatory environment affecting our
business; and



market conditions in our industry and the economy as a whole.

In addition, the stock market in general, and the market for
technology companies in particular, have experienced extreme
price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of those
companies. These broad market and industry factors may seriously
harm the market price of our common stock, regardless of our
actual operating performance. Also, in the past, following
periods of volatility in the overall market and the market price
of a companys securities, securities class action
litigation has often been instituted against these companies.
This litigation, if instituted against us, could result in
substantial costs and a diversion of our managements
attention and resources and could harm the price of

our common stock. Although we carry general liability and errors
and omissions insurance, our insurance may not cover claims of
these types or may be inadequate to protect us from all
liability that we may incur.

Our share price could decline due to the large number of
outstanding shares of our common stock eligible for future
sale.

The market price of our common stock could decline as a result
of sales of substantial amounts of our common stock in the
public market, or from the perception that these sales could
occur. These sales could also make it more difficult for us to
sell our equity or equity-related securities in the future at a
time and price that we deem appropriate.

As of December 31, 2005, we had 20,273,304 shares of
common stock outstanding. The 5,232,500 shares sold
pursuant to our November 2004 initial public offering are
currently tradable without restriction. Almost all of the
remaining shares are eligible for sale, subject in some cases to
the volume and other restrictions of Rule 144 and
Rule 701 under the Securities Act of 1933.

In addition, we have registered approximately
4,942,807 shares of common stock that have been issued or
reserved for future issuance under our stock incentive plans. Of
those shares, options for 2,074,629 shares were vested as
of December 31, 2005 and, if those options are exercised,
those shares are eligible for sale. Also as of December 31,
2005, we had outstanding warrants for 4,603,088 shares that
were fully vested and, if those warrants are exercised, those
shares will be eligible for sale after the expiration of the
lock-up agreements.

Our principal stockholders, executive officers and
directors own a significant percentage of our stock, and as a
result, the trading price for our shares may be depressed and
these stockholders can take actions that may be adverse to your
interests.

Our executive officers and directors and entities affiliated
with them, in the aggregate, beneficially own over half of our
common stock. This significant concentration of share ownership
may adversely affect the trading price for our common stock
because investors often perceive disadvantages in owning stock
in companies with controlling stockholders. These stockholders,
acting together, will have the ability to exert control over all
matters requiring approval by our stockholders, including the
election and removal of directors and any proposed merger,
consolidation or sale of all or substantially all of our assets.
In addition, these stockholders who are executive officers or
directors, or who have representatives on our board of
directors, could dictate the management of our business and
affairs. This concentration of ownership could have the effect
of delaying, deferring or preventing a change in control, or
impeding a merger or consolidation, takeover or other business
combination that could be favorable to you.

Our charter documents and Delaware law could prevent a
takeover that stockholders consider favorable and could also
reduce the market price of our stock.

Our amended and restated certificate of incorporation and our
bylaws contain provisions that could delay or prevent a change
in control of our company. These provisions could also make it
more difficult for stockholders to elect directors and take
other corporate actions. These provisions include:



providing for a classified board of directors with staggered,
three-year terms;



not providing for cumulative voting in the election of directors;



authorizing the board to issue, without stockholder approval,
preferred stock with rights senior to those of common stock;



prohibiting stockholder action by written consent;



limiting the persons who may call special meetings of
stockholders; and

In addition, the provisions of Section 203 of Delaware
General Corporate Law govern us. These provisions may prohibit
large stockholders, in particular those owning 15% or more of
our outstanding voting stock, from merging or combining with us
for a certain period of time.

These and other provisions in our amended and restated
certificate of incorporation, our bylaws and under Delaware law
could discourage potential takeover attempts, reduce the price
that investors might be willing to pay for shares of our common
stock in the future and result in the market price being lower
than it would be without these provisions.

Item 1B.

Unresolved Staff Comments:

None.

Item 2.

Properties:

Our principal executive offices are located in a leased facility
in Emeryville, California, consisting of approximately
23,803 square feet of office space, under a lease that
expires in January 2012. This facility accommodates our
principal administrative and finance operations. We occupy a
leased facility in each of our operating districts to
accommodate offices for our district director and support staff.
We generally do not provide office space for our ZipAgent force.
We do not own any real property. We believe that our leased
facilities are adequate to meet our current needs and that
additional facilities will be available for lease to meet our
future needs.

Item 3.

Legal Proceedings:

On August 3, 2005, we were named in a class action lawsuit
filed in Superior Court of the State of California, County of
San Diego, Central Division, Sullivan,
et al v. ZipRealty, case number GIC851801, by two
former employee agents. The plaintiffs alleged, among other
things, that our expense allowance policies violated California
law. We reached an agreement to settle this claim in exchange
for a payment of $4.2 million. The agreement, which
included a full release from any further liability on this
issue, was granted preliminary court approval on
October 21, 2005 and final court approval on
February 10, 2006. We have made full payment under the
settlement agreement.

We are not currently subject to any other material legal
proceedings. From time to time we have been, and we currently
are, a party to litigation and subject to claims incident to the
ordinary course of our business. The amounts in dispute in these
matters are not material to us, and we believe that the
resolution of these proceedings will not have a material adverse
effect on our business, results of operations, financial
position, or cashflows.

Our common stock began trading on the Nasdaq National Market
under the symbol ZIPR on November 10, 2004. We
have not listed our stock on any other markets or exchanges. The
following table shows the high and low closing prices for our
common stock as reported by the Nasdaq National Market:

High

Low

2004 Calendar year

Fourth Quarter (November 10 to December 31, 2004)

$

19.20

$

14.75

2005 Calendar year

First Quarter

$

18.34

$

13.35

Second Quarter

$

15.92

$

12.30

Third Quarter

$

14.17

$

12.13

Fourth Quarter

$

13.73

$

7.87

As of March 1, 2006, we had approximately 164 common
stockholders of record and a substantially greater number of
beneficial owners.

Dividend policy

We have never declared or paid dividends on our common stock. We
intend to retain our earnings for use in our business and
therefore we do not anticipate declaring or paying any cash
dividends in the foreseeable future.

Use of proceeds

On November 9, 2004, the Securities and Exchange Commission
declared effective our Registration Statement on
Form S-1 (File
No. 333-115657)
for our initial public offering. We commenced our offering
immediately thereafter. We completed our sale of
4,550,000 shares of common stock on November 15, 2004
at a price of $13.00 per share, and on November 18,
2004 we sold the remainder of our registered shares of common
stock (682,500 shares) at the same price per share pursuant
to the underwriters exercise of the over-allotment option.
UBS Securities LLC, Deutsche Bank Securities Inc., Thomas Weisel
Partners LLC and Pacific Growth Equities, LLC acted as the
underwriters for the offering.

The aggregate purchase price of the offering was $68,022,500.
The net offering proceeds received by us after deducting total
estimated expenses were $61,402,757. We incurred total estimated
expenses in connection with the offering of $6,619,743, which
consisted of $1,795,943 in legal, accounting and printing fees,
$4,761,575 in underwriters discounts, fees and
commissions, and $62,225 in miscellaneous expenses. No payments
for such expenses were made directly or indirectly to
(i) any of our directors, officers or their associates,
(ii) any person owning 10% or more of any class of our
equity securities or (iii) any of our affiliates.

We have not used any of the net offering proceeds from the
offering for operational purposes. We currently estimate that we
will use the net proceeds as described in the prospectus for the
offering: for general corporate purposes, including working
capital. We have not assigned specific portions of the net
proceeds for any particular uses, and we will retain broad
discretion in the allocation of the net proceeds. Although we
evaluate potential acquisitions of complementary businesses,
technologies or other assets in the ordinary course of business,
we have no specific understandings, commitments or agreements
with respect to any acquisition at this time.

Pending such uses, we have invested all of the net proceeds from
the offering in short-term, investment-grade securities. We
cannot predict whether the net proceeds invested will yield a
favorable return.

The following selected financial data should be read in
conjunction with Item 7. Managements Discussion
and Analysis of Financial Condition and Results of
Operations and Item 8. Financial Statements and
Supplementary Data.

Managements Discussion and Analysis of Financial
Condition and Results of Operations:

The following discussion should be read together with our
financial statements and related notes appearing elsewhere in
this report. This discussion contains forward-looking statements
based upon current expectations that involve numerous risks and
uncertainties. Our actual results could differ materially from
those anticipated in these forward-looking statements for many
reasons, including but not limited to those set forth in
Risk Factors in Item 1A of Part I of this
report and elsewhere in this report. We undertake no obligation
to update any information contained in these forward-looking
statements.

OVERVIEW

General

We are a full-service residential real estate brokerage firm,
using the Internet, proprietary technology and efficient
business processes to provide home buyers and sellers with
high-quality service and value. Our solution includes a
client-centric business approach, a sophisticated website that
empowers home buyers and sellers with relevant information, a
proprietary business management technology platform and
significant financial savings for consumers. We share a portion
of our commissions with our buyer clients in the form of a cash
rebate, and typically represent our seller clients at fee levels
below those offered by most traditional brokerage companies in
our markets. Generally, our seller clients pay a total brokerage
fee of 4.5% to 5.0% of the transaction value, of which 2.5% to
3.0% is paid to agents representing buyers.

Our net revenues are comprised primarily of commissions earned
as agents for buyers and sellers in residential real estate
transactions. We record revenues net of rebate or commission
discount, if any, paid or offered to our clients. We also
receive revenues from certain co-marketing arrangements, such as
our relationship with
E-LOAN, Inc., which
provides the mortgage center on our website and pays us a flat
monthly fee that is established on a periodic basis. Generally,
non-commission revenues represent less than 5% of our net
revenues during any period. Our net revenues are principally
driven by the number of transactions we close and the average
net revenue per transaction. Average net revenue per transaction
is a function of the home sales price and percentage commission
we receive on each transaction.

We were founded in 1999, currently have operations in 16 major
metropolitan areas, and as of December 31, 2005 employed
1,556 people, of whom 1,366 were ZipAgents. We commenced
operations in Las Vegas in April 2005, in Houston in June 2005,
in Miami, Florida in October 2005 and in Tampa, Florida in
February 2006. We currently plan to open three to five
additional markets later in the year.

Trends in our business

Our business has experienced rapid growth since our inception in
1999, primarily as a result of increased transaction volume and
increased average net revenue per transaction. In 2005, we
generated $93.4 million in net revenues, compared to
$62.3 million in 2004 and $33.8 million in 2003. The
number of our closed transactions increased from approximately
5,394 in 2003 to approximately 8,500 in 2004 to approximately

12,317 in 2005, and our average net revenue per transaction
increased from approximately $6,058 in 2003 to approximately
$7,147 in 2004 to approximately $7,395 in 2005. Our transaction
volume is primarily driven by the number of ZipAgents we employ,
which increased from 440 at December 31, 2003 to 914 at
December 31, 2004 to 1,366 at December 31, 2005. Our
average net revenue per transaction increased over this time
primarily as a result of increasing home prices and a reduction
in our rebate paid to buyers. As we add additional ZipAgents, we
believe we will continue to increase our transaction volume and
grow our business. In order to help agents become productive
more quickly, we intend to hire agents who already work for
competing brokerage firms in our existing markets. By hiring
those established agents who we anticipate will be successful
within our business model, we believe we can increase our
transaction volume without materially diluting the number of
potential transactions per agent allowing us to further increase
our market share. In addition, we believe that customer
acquisition is one of our core competencies, and while we
anticipate that the difficulty of acquiring a sufficient number
of leads online may increase over time, we expect that we can
mitigate some of that impact with repeat and referral business,
as well as by increasing our visibility and credibility to
potential clients over time. Since our market share has averaged
less than 1% over the past twelve months in our existing markets
in aggregate, we believe that there is significant opportunity
to increase our market share and grow our revenues, even if the
overall level of sales decline due to changing consumer
sentiment, interest rate increases or other economic or
geopolitical factors. However, we anticipate the pace of our
growth in percentage terms to slow as our company increases in
size.

Since early September of 2005 we have experienced a significant
increase in the available inventory of homes for sale in many of
our markets, as well as an increase in the amount of time
listings are taking to sell. Pricing increases have also slowed,
and some markets have shown declines in median selling prices
over this period. According to NAR, nationally sales of existing
homes fell 5.2% year-over-year in January 2006 to a seasonally
adjusted annual rate of 6.6 million, the lowest in nearly
two years. This represented the fifth month in a row that sales
have declined. Moreover, inventory of unsold homes is the
largest since August of 1998. In the state of California, the
California Association of REALTORS reported that sales of
existing homes declined 24.1% year-over-year during the month of
January 2006. In our opinion, these data points suggest the
housing market is in a period of transition, with more power
shifting to buyers from sellers. While over the long-term we
believe a more balanced market will be beneficial to our model,
which relies primarily on representing buyers, during this
period of transition we may continue to experience reduced
growth rates and agent productivity versus our historical levels
as buyers react cautiously to perceived changing market
conditions.

Over time, we have made significant adjustments to our cost
structure and revenue model in order to improve the financial
results of our business. We have modified the compensation and
expense reimbursement structure for ZipAgents over time, most
recently in February 2006. Currently, our ZipAgents earn a
compensation package consisting of a percentage of the
commissions they generate for us that ranges from 35% to 80% of
our net revenues after deducting certain other items. We also
provide our ZipAgents with health, retirement and other
benefits, and pay for certain marketing costs and other business
expenses. ZipAgents may also be granted equity incentives based
on performance. We currently believe that our most recent
modifications will not materially impact our operating margins.
We may make further modifications to our compensation structure
in the future.

We have lowered our buyer rebate percentage several times to
improve our revenue model. In March 2004, we reduced our buyer
rebate to 20% of our commission from 25% of our commission, up
to a maximum of 1% of the home sales price. The effect of the
buyer rebate reduction was recognized over a phase-in period of
approximately two to four months as the reduction only affected
new clients immediately while existing clients continued under
the prior rebate policy for transactions already in progress and
for transactions opened within a short period after the
reduction was announced. We implemented these buyer rebate
percentage reductions for several reasons, including our
determination that our growing reputation for superior service
allowed us not to compete solely on price, our efforts to
improve our revenue model and agent compensation model, and our
desire to offer a simplified rebate structure to our clients.

We achieved profitability for the first time in the third
quarter of 2003 and maintained profitability for the fourth
quarter as well, primarily as a result of increased transaction
volume, higher average net revenue per transaction and improved
management of discretionary expenses. However, as a result of
the seasonality to which our business is subject, we again
experienced a net loss in the first quarter of 2004. We returned
to profitability in the second, third and fourth quarters of
2004, primarily as a result of higher average net transaction
revenue and increased transactional volume due to our increased
ZipAgent force and seasonal factors. We achieved profitability
in the first quarter of 2005, the first time in our seasonally
slow first quarter, primarily as a result of higher average net
transaction revenues and increased transactional volume due to
our increased ZipAgent force. While we experienced a net loss in
the second quarter of 2005 as a result of a one-time charge
relating to the settlement of a threatened class action lawsuit,
we would have been profitable excluding the effect of this
settlement. We again achieved profitability in the third and
fourth quarters of 2005, but because of seasonality as well as
the current softening in the residential real estate market, we
expect to experience a net loss in the first quarter of 2006.

Over the past several years there has been a decline in average
commissions charged in the real estate brokerage industry, in
part due to companies such as ours exerting downward pressure on
prices with a lower commission structure, as well as by what, in
our view, appears to be an increase in consumer willingness to
negotiate fees with their agents. We believe that many consumers
are focusing on absolute commission dollars paid to sell their
home as opposed to accepting a traditional standard market
commission percentage. According to REAL Trends, while the
average commission percentage decreased from 5.44% in 2000 to
5.08% in 2004, total commission revenues increased from
$42.6 billion to $61.1 billion during that same
period, influenced by steadily increasing sales volumes and
higher median sales prices. In the event that commissions
continue to decline, we have designed our business model around
an attractive cost structure and operational efficiencies which
we believe should allow us to continue to offer our services at
prices less than those charged by the majority of our
competitors.

Market seasonality, cyclicality and interest rate
influences

The residential real estate brokerage market is influenced both
by annual seasonality factors, as well as by overall economic
cycles. While individual markets vary, transaction volume
activity nationally tends to progressively increase from January
through the summer months, then gradually slows over the last
three to four months of the calendar year. Revenues in each
quarter are significantly affected by activity during the prior
quarter, given the typical 30- to
45-day time lag between
contract execution and closing. While we believe that
seasonality has been somewhat masked by our overall growth, we
have been, and believe we will continue to be, influenced by
overall market activity and seasonal forces. We generally
experience the most significant impact in the first and fourth
quarters of each year, when our revenues are typically lower
relative to the second and third quarters as a result of
traditionally slower home sales activity and reduced listings
inventory between Thanksgiving and Presidents Day.

We believe that the overall macroeconomic environment and
periodic business cycles can influence the general health of the
residential real estate market at any given point in time.
Generally, when economic times are fair or good, the housing
market tends to perform well. If the economy is weak, interest
rates dramatically increase, or there are market events such as
terrorist attacks or threats, the outbreak of war or
geopolitical uncertainties, the housing market could be
negatively impacted.

Over the past several decades, the national residential real
estate market has demonstrated significant growth, with annual
existing home sales volume growing from 1.6 million in 1970
to approximately 6.8. million in 2004 and median existing
home sales prices increasing every year during that period.
During that period, the volume of existing home sales has
declined for at least two consecutive years only twice, namely
1979 through 1982 and 1989 through 1990. The declines in sales
volumes in the 1979 through 1982 period occurred while interest
rates were at historic highs, with long-term U.S. Treasury
rates exceeding 10%. With rates remaining at similarly high
levels, housing activity expanded during the period from 1983
through 1986. Average interest rates were lower during the
second period of consecutive year declines, 1989 through 1990,
than in 1988.

Many factors influence an individuals decision to buy or
sell a home, and we believe that no one factor alone determines
the health of the residential real estate market. For example,
while a rise in interest rates could lead to lower demand for
housing or put downward pressure on prices, it is our experience
that lifestyle influences, such as job relocation, changes in
family dynamics or a desire to change neighborhoods,
significantly impact the demand for residential real estate. In
addition, periods of interest rate increases are often
characterized by improving economic fundamentals, which can
create jobs, increase incomes and bolster consumer confidence,
all of which are factors that positively influence housing
demand. It is difficult to predict which influences will be
strongest, and ultimately whether the housing market will be
affected positively or negatively when faced with numerous
influences.

While we do not believe that increasing interest rates will
necessarily have a negative impact on the housing market,
increasing interest rates may lead to a lower demand for housing
or put downward pressure on prices. Higher interest rates could
increase monthly housing payments or reduce the amount an
individual can pay, which may have an adverse effect on pricing
and affordability. It is also possible that home ownership
rates, which reached an all time high in 2004 during the recent
period of record low interest rates, could drop as a result of
fewer first-time buyers being able to afford homes. Should
overall transaction activity or sales prices decline, overall
commissions generated in the industry could decline as well,
potentially causing the roughly $61 billion in annual
commissions generated in 2004 to decline. However, should the
addressable market for our services decline somewhat due to
decreasing sales volume or prices, we believe the overall size
of the market on an absolute basis will remain very large,
providing ample addressable opportunity for us to continue to
grow our business through increasing our market share.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements are prepared in accordance with
accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to
make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues, costs and expenses and related
disclosures. On an ongoing basis, we evaluate our estimates and
assumptions. Accordingly, our actual results may differ from
these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 1
of the notes to our financial statements, and of those policies,
we believe that the following accounting policies involve the
greatest degree of judgment and complexity. Accordingly, these
are the policies we believe are the most critical to understand
and evaluate our financial condition and results of operations.

Revenue recognition

We derive the substantial majority of our revenues from
commissions earned as agents for buyers and sellers in
residential real estate transactions. We recognize commission
revenues upon closing of a sale and purchase transaction, net of
any rebate or commission discount, or transaction fee
adjustment, as evidenced by the closure of the escrow or similar
account and the transfer of these funds to all appropriate
parties. We recognize non-commission revenues from our other
business relationships, such as our
E-LOAN marketing
relationship, as the fees are earned from the other party
typically on a monthly fee basis. Revenues are recognized when
there is persuasive evidence of an arrangement, the price is
fixed or determinable, collectibility is reasonably assured and
the transaction has been completed.

Internal-use software and website development costs

We account for internal-use software and website development
costs, including the development of our ZipAgent Platform, in
accordance with the guidance set forth in Statement of Position
98-1, Accounting for the Cost of Computer Software Developed
or Obtained for Internal Use and Emerging Task Force Issue
No. 00-02,Accounting for Website Development Costs. We capitalize
the payroll and direct payroll-related costs of employees who
devote time to the development of internal-use software. We
amortize these costs over their estimated useful lives, which is
generally 15 months. Our judgment is required in
determining the point at which various projects enter the stages
at which costs may be capitalized, in assessing the ongoing
value of

the capitalized costs, and in determining the estimated useful
lives over which the costs are amortized. The estimated life is
based on managements judgment as to the product life cycle.

Deferred stock-based compensation

We account for employee stock-based compensation in accordance
with provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees, or
APB 25, and Financial Accounting Standards Board
Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation  an
Interpretation of APB No. 25, and comply with the
disclosure provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based
Compensation, or SFAS 123, and related Statement of
Financial Accounting Standard No. 148, Accounting for
Stock-Based Compensation  Transaction and
Disclosure. Under APB 25, compensation expense is based
on the difference, if any, on the date of the grant, between the
fair value of our stock and the exercise price of the option. We
amortize deferred stock-based compensation using the
straight-line method over the vesting period. We account for
equity instruments issued to non-employees in accordance with
the provisions of SFAS 123 and Emerging Task Force Issue
No. 96-18, Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling, Goods or Services. On March 29, 2005, the
Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 107, or SAB 107,
which provides the SEC Staffs views regarding interactions
between Statement of Financial Accounting Standard No. 123
(Revised 2004), Share-Based Payment, or SFAS 123R,
and certain SEC rules and regulations and provides
interpretations of the valuation of share-based payments for
public companies. Effective with annual periods beginning after
June 15, 2005, we will account for employee stock-based
compensation in accordance with the provisions of SFAS 123R
and SAB 107 which requires companies to expense the value
of employee stock options and similar awards. We will adopt
SFAS 123R in the first quarter of 2006 using the modified
prospective method. We will apply the Black-Scholes model to
estimate the fair value of share-based payments to employees,
which will then be amortized on a ratable basis over the
requisite service period.

The accounting for and disclosure of employee and non-employee
equity instruments, primarily stock options and preferred and
common stock warrants, requires judgment by management on a
number of assumptions, including the fair value of the
underlying instrument, estimated lives of the outstanding
instruments, and the instruments volatility. Changes in
key assumptions will impact the valuation of such instruments.
Because there was no public market for our stock prior to our
initial public offering in November 2004, our board of directors
determined the fair value of our common and preferred stock
based on several factors, including, but not limited to, our
operating and financial performance, recent sales of convertible
debt instruments and internal valuation analyses considering key
terms and rights of the related instruments. We have issued
warrants primarily in relation to our convertible debt
arrangements, and to a lesser degree, to certain service
providers. Amounts recorded in conjunction with our convertible
debt arrangements are generally amortized to interest expense
over the expected life of the debt using the effective interest
method.

For options granted after our initial public offering, the fair
value of our common stock is the closing price of our stock on
the Nasdaq National Market on the date the option was granted.
For options which were granted prior to our initial public
offering, the deemed fair value of our common stock was
determined by our board of directors, with input from
management, utilizing the market approach, considering a number
of factors, including, but not limited to:



comparable values of similar companies and the pricing of recent
rounds of financing;



revenue growth and profitability milestones achieved and as
measured to budget;

We recorded deferred stock-based compensation of $0,
$0.4 million and $0.3 million and amortization of such
deferred compensation of approximately $140,000, $159,000 and
$85,000 in the years ended December 31, 2005, 2004 and
2003, respectively. Had different assumptions or criteria been
used to determine the deemed fair value of the stock options,
materially different amounts of stock compensation expenses
could have been reported.

Income taxes

Deferred tax assets and liabilities arise from the differences
between the tax basis of an asset or liability and its reported
amount in the financial statements as well as from net operating
loss and tax credit carry forwards. Deferred tax amounts are
determined by using the tax rates expected to be in effect when
the taxes will actually be paid or refunds received, as provided
under current tax law. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected
to be realized. Income tax expense or benefit is the tax payable
or refundable, respectively, for the period plus or minus the
change during the period in deferred tax assets and liabilities.

Historically, we have recorded a valuation allowance on our
deferred tax assets, the majority of which relate to net
operating loss tax carryforwards generated before we achieved
profitability. During the fourth quarter 2005, we concluded that
it is more likely than not that we will be able to realize the
benefit of a significant portion of these deferred tax assets in
the future. Consequently, we recognized a net tax benefit of
$16.7 million resulting primarily from the release of a
significant portion of the net deferred tax valuation allowance.

At December 31, 2005, we had federal and state net
operating loss carryforwards of approximately $45 million
and $29 million, respectively, available to offset future
taxable income. If not utilized, the federal and state net
operating losses will begin to expire in 2020 for federal and
2010 for state tax purposes, respectively.

The Tax Reform Act of 1986 limits the use of net operating loss
and tax credit carryforwards in certain situations where changes
occur in the stock ownership. We have federal and state net
operating losses of approximately $1 million at
December 31, 2005 that are subject to annual limitations of
$20,000.

The difference between our effective income tax rate and the
federal statutory rate is primarily a function of the release of
the valuation allowance provided against the net deferred tax
assets and permanent differences. Our future effective income
tax rate will depend on various factors, such as changes in our
valuation allowance, pending or future tax law changes including
rate changes and the tax benefit from research and development
credits, potential limitations on the use of federal and state
net operating losses, and state taxes.

Net income (loss) available to common stockholders reflects the
effect of cumulative and non-cumulative dividends on the
Companys redeemable convertible preferred stock which all
converted to common stock upon the closing of the Companys
initial public offering on November 15, 2004. No dividend
was ever declared or paid by the Company, and all rights to such
dividends terminated on the date of the Companys initial
public offering as a result of the conversion of all outstanding
shares of preferred stock into common stock.

To supplement our statement of operations and net income (loss)
per share data, pro forma basic and diluted net income loss per
share have been computed to (i) give effect to the
conversion of redeemable convertible preferred stock into common
stock upon the closing of the Companys initial public
offering on an as-if-converted basis for the years ended
December 31, 2005, 2004 and 2003 as if such conversion
occurred at the beginning of the respective period or original
issue date, if later; and (ii) remove from net income
(loss) available to common stockholders the effect of dividends
and earnings allocated to preferred stockholders. This non-GAAP
adjustment is provided to enhance the users overall
understanding of our current financial performance and to
provide comparability with future per share calculations.
Specifically, we believe the non-GAAP results provide useful
information to both management and investors by excluding the
effect of dividends that were never declared and/or paid and to
assume the conversion of redeemable convertible preferred stock
to common stock at the beginning of all periods displayed. The
unaudited non-GAAP pro forma net income (loss) per share should
not be considered in isolation or as a substitute for financial
information presented in accordance with generally accepted
accounting principles, and may be different from non-GAAP
measures used by other companies. The unaudited pro forma net
income (loss) per share should be reviewed in conjunction with
the following schedule that provides a quantitative
reconciliation of the differences between such calculation and
the financial information presented in accordance with generally
accepted accounting principles.

The following table sets forth the computation of pro forma
basic and dilutive net income (loss) per share for the period
indicated:

The substantial increase in our net revenues for 2005 compared
to 2004 was primarily due to increased transaction volume and an
increase in average net revenue per transaction. Transaction
volume increased by 45% and contributed $27.3 million
resulting from 12,317 transactions closed in 2005 compared to
8,500 transactions closed in 2004. Our transaction volume
increased as we added additional ZipAgents in our existing
markets which allowed us to attract and service new clients.
Additionally, we continued adding new agents in Las Vegas,
Houston and Miami as we commenced operations in April 2005, June
2005 and October 2005, respectively. Transaction volume
from Las Vegas, Houston and Miami contributed 9% of the
increased transactions closed in 2005. We had 1,366 ZipAgents at
December 31, 2005 compared to 914 at December 31,
2004. Average net revenue per transaction increased by 5.0% and
contributed $3.1 million resulting primarily from
representing buyers and sellers in transactions for higher
priced homes in 2005 and as a result of a consumer rebate
reduction in March 2004. Of the 5% increase in average net
revenue per transaction, approximately 3% and $2.0 million
were due to higher home prices, and 2% and $1.1 million
were due to our consumer rebate reductions. In March 2004, we
lowered the rebate from 25% to 20%; the phase in of this
reduction was completed by the end of the second quarter of
2004. We anticipate average net revenue per transaction to
decrease modestly during 2006 as we grow our business in markets
with lower home prices and, additionally, we anticipate the rate
of price increases in existing home sales to slow relative to
current levels and that home prices may decline in some markets.
The increase in referral and other revenues was not significant.

We expect that the overall market for our services will continue
to improve in 2006 as we expand our force of ZipAgents in
existing markets and continue to expand into new markets.

Cost of revenues

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

Cost of revenues

$

51,084

$

33,858

$

17,226

50.9

%

Our cost of revenues consists principally of commissions,
related payroll taxes, benefits and expense allowances and
reimbursements paid to our ZipAgents, and the amortization of
internal-use software and website development costs which relate
primarily to our ZAP technology.

The increase in cost of revenues for 2005 compared to 2004 was
due primarily to an increase in commissions, related payroll
costs and expense allowances and reimbursements of approximately
$17.2 million related to our growth in net transaction
revenues. As a percentage of net revenues, cost of revenues
increased by 0.3 percentage points due primarily to the mix
of commission splits earned by our ZipAgents.

We expect our cost of revenues to increase in 2006 in absolute
dollars as we continue to grow our business, but to remain
relatively consistent or to increase modestly as a percentage of
net revenues.

Product development

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

Product development

$

2,749

$

2,245

$

504

22.4

%

Product development expenses include our information technology
costs, primarily compensation and benefits for our product
development personnel, depreciation of equipment, communications
expenses and other operating costs relating to the maintenance
of our website and our proprietary technology systems.

The increase in product development expenses for 2005 compared
to 2004 was due to growth in our business and consisted of
increases in salaries and benefits of approximately
$0.4 million and information technology of
$0.1 million. As a percentage of net revenues, product
development expenses decreased 0.7 percentage points in the
period due primarily to the significant growth in our net
revenues.

We expect our product development expenses to increase in 2006
in absolute dollars and as a percentage of net revenues as we
continue to grow our business.

Marketing and business development

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

Marketing and business development

$

12,303

$

8,821

$

3,482

39.5

%

Marketing and business development expenses include compensation
and benefits of our marketing and business development personnel
and costs relating to our marketing, advertising and client
acquisition activities.

The increase in marketing and business development expenses in
2005 compared to 2004 was due to growth in our business and
consisted primarily of increased lead generation spending of
approximately $3.7 million necessary to support the
increase in the number of ZipAgents, an increase of
approximately $0.5 million in salaries and benefits
partially offset by a decrease of approximately
$0.7 million in advertising. As a percentage of net
revenues, marketing and business development expenses decreased
1.0 percentage points in the period due primarily to the
significant growth in our net revenue.

We expect our marketing and business development expenses to
increase in 2006 in absolute dollars but to remain relatively
consistent as a percentage of net revenues, as we acquire more
leads for our expanding ZipAgent force and potentially expand
offline marketing and advertising campaigns to enhance our brand
and expand into new markets.

General and administrative

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

General and administrative

$

21,939

$

14,342

$

7,597

53.0

%

General and administrative expenses consist of compensation and
benefits costs of our corporate employees, field support and
management personnel, occupancy costs, legal and accounting
fees, and other general operating support costs.

The increase in general and administrative expenses in 2005
compared to 2004 was due to growth in our business and consisted
primarily of approximately $1.9 million related to
increased salaries and benefits, $0.2 million of travel
expenses, $0.1 million of information technology,
$0.9 million of related operating costs for our additional
management and support personnel in our district sales offices
and approximately $0.4 million related to recruiting and
training our expanding ZipAgent force. Additionally, corporate
office expenses increased for the same period due to
approximately $1.0 million of salaries and benefits,
$0.3 million of travel, $0.8 million of operating
costs and approximately $1.6 million of outside accounting
and other professional costs relating primarily to operating as
a public company including Sarbanes-Oxley Section 404
compliance costs. As a percentage of net revenues, general and
administrative expenses increased 0.5 percentage points for
the same period.

As we expand our business and incur additional costs associated
with being a public company, particularly Sarbanes-Oxley
Section 404 compliance, we expect our general and
administrative expenses to increase in 2006 in absolute dollars
and as a percentage of net revenues.

We record deferred employee stock-based compensation for the
excess of the estimated fair value of the shares of common stock
subject to such options over the exercise price of these options
at the date of grant. We amortize deferred stock-based
compensation expense over the vesting periods of the individual
options on the straight-line method. Outstanding options will
continue to vest over future periods so long as the optionee
continues in service to us. At December 31, 2005, we had
approximately $0.3 million in deferred employee stock-based
compensation on our balance sheet.

Stock based compensation will increase starting on
January 1, 2006 when we will begin accounting for employee
stock-based compensation in accordance with the provisions of
SFAS 123R. See further discussion in Recent Accounting
Pronouncements in Note 1 titled The Company and
Summary of Significant Accounting Policies of our Notes to
Financial Statements.

Litigation

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

Litigation

$

4,164

$



$

4,164

100.0

%

Litigation relates to a class action lawsuit filed by two former
ZipAgents. The plaintiffs allege, amount other things, that our
expense allowance policies violate California law. We have
reached an agreement to settle this claim in exchange for our
payment of $4.2 million. The agreement includes a full
release from any further liability on this issue and has
received preliminary court approval on October 21, 2005 and
final court approval on February 10, 2006. We made the
final payment under the settlement agreement in February 2006.

Interest income

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

Interest income

$

2,741

$

411

$

2,330

566.8

%

Interest income relates to interest we earn on our money market
deposits and short-term investments. Interest income will
fluctuate as our cash and short-term investment balances change
and applicable interest rates increase or decrease. The increase
in interest income in 2005 compared to 2004 was due primarily to
interest earned for a full year on investing the proceeds from
our initial public offering in November, 2004.

Other income (expense), net

Year Ended

December 31,

Increase

Percent

2005

2004

(Decrease)

Change

(In thousands)

Other income (expense), net

$

(14

)

$

(1

)

$

(13

)

2,410.3

%

Other income (expense), net consists of non-operating items,
which have not been significant to date.

During the fourth quarter 2005, we concluded that it was more
likely than not that we would be able to realize the benefit of
a significant portion of our deferred tax assets in the future.
Consequently, we recognized a net tax benefit of
$16.7 million resulting primarily from the release of a
significant portion of the net deferred tax valuation allowance.
We recorded a provision for income taxes in 2004 attributable to
federal and state alternative minimum taxes currently payable
due to limits on the amount of net operating losses that may be
applied against income earned in 2004 under current tax
regulations. At December 31, 2004, we maintained a full
valuation allowance against our deferred tax assets based on the
determination that it was more likely than not that the deferred
tax assets would not be realized.

Comparison of the years ended December 31, 2004 and
December 31, 2003

Net revenues

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

Net revenues

$

62,288

$

33,807

$

28,481

84.2

%

The substantial increase in our net revenues for 2004 compared
to 2003 was primarily due to increased transaction volume and an
increase in average net revenue per transaction. Transaction
volume increased by 58% and contributed $18.8 million
resulting from 8,500 transactions closed in 2004 compared to
5,394 transactions closed in 2003. Our transaction volume
increased as we added additional ZipAgents in our existing
markets which allowed us to attract and service new clients. We
had 914 ZipAgents at December 31, 2004 compared to 440 at
December 31, 2003. Average net revenue per transaction
increased by 18% and contributed $9.2 million resulting
primarily from representing buyers and sellers in transactions
for higher priced homes in 2004 and as a result of two consumer
rebate reductions. Of the 18% increase in average net revenue
per transaction, approximately 13% and $6.5 million were
due to higher home prices, and 5% and $2.7 million were due
to our consumer rebate reductions. In September 2002, we lowered
the rebate we paid to our buyer clients from 33.3% of our
commission to 25% of our commission; the phase in of this
reduction was completed in early 2003. In March 2004, we further
lowered the rebate from 25% to 20%; the phase in of this
reduction was completed by the end of the second quarter of 2004.

Cost of revenues

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

Cost of revenues

$

33,858

$

19,929

$

13,929

69.9

%

Our cost of revenues consists principally of commissions,
related payroll taxes, benefits and expense allowances paid to
our ZipAgents, and the amortization of internal-use software and
website development costs which relate primarily to our ZAP
technology.

The increase in cost of revenues for 2004 compared to 2003 was
due primarily to an increase in commissions, related payroll
costs and expense allowances of approximately $13.8 million
related to our growth in net transaction revenues. As a
percentage of net revenues, cost of revenues decreased by
4.5 percentage points due primarily to the ZipAgent
compensation changes we implemented from late 2002 through 2003.

Product development expenses include our information technology
costs, primarily compensation and benefits for our product
development personnel, depreciation of equipment, communications
expenses and other operating costs relating to the maintenance
of our website and our proprietary technology systems.

The increase in product development expenses for 2004 compared
to 2003 was due to growth in our business and consisted of
increases in salaries and benefits of approximately
$0.3 million, consulting of $0.1 million and
communications costs of approximately $0.1 million. As a
percentage of net revenues, product development expenses
decreased 1.5 percentage points in the period due primarily
to the significant growth in our net revenues.

Marketing and business development

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

Marketing and business development

$

8,821

$

5,003

$

3,818

76.3

%

Marketing and business development expenses include compensation
and benefits of our marketing and business development personnel
and costs relating to our marketing, advertising and client
acquisition activities.

The increase in marketing and business development expenses in
2004 compared to 2003 was due to growth in our business and
consisted primarily of increased lead generation spending of
approximately $2.2 million necessary to support the
increase in the number of ZipAgents and an increase of
approximately $1.4 million in marketing and advertising as
we commenced a print and radio campaign in the second quarter of
2004 in connection with our redesigned logo and branding effort.
As a percentage of net revenues, marketing and business
development expenses decreased 0.6 percentage points in the
period due primarily to the significant growth in our net
revenue.

General and administrative

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

General and administrative

$

14,342

$

9,464

$

4,878

51.5

%

General and administrative expenses consist of compensation and
benefits costs of our corporate employees, field support and
management personnel, occupancy costs, legal and accounting
fees, and other general operating support costs.

The increase in general and administrative expenses in 2004
compared to 2003 was due to growth in our business and consisted
primarily of approximately $1.8 million related to
increased salaries and benefits, $0.1 million of travel
expenses, $0.1 million of communications costs and
$0.5 million of related operating costs for our additional
management and support personnel in our district sales offices
and approximately $0.5 million related to recruiting and
training our expanding ZipAgent force. Additionally corporate
office expenses increased due to approximately $0.9 million
of salaries and benefits, $0.2 million of operating costs
and approximately $0.5 million of outside accounting and
other professional costs. As a percentage of net revenues,
general and administrative expenses decreased
5.0 percentage points in the period due primarily to the
significant growth in our net revenues.

We record deferred employee stock-based compensation for the
excess of the estimated fair value of the shares of common stock
subject to such options over the exercise price of these options
at the date of grant. We amortize deferred stock-based
compensation expense over the vesting periods of the individual
options on the straight-line method. Outstanding options will
continue to vest over future periods so long as the optionee
continues in service to us. At December 31, 2004, we had
approximately $0.4 million in deferred employee stock-based
compensation on our balance sheet.

Interest expense

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

Interest expense

$



$

(2,273

)

$

(2,273

)

(100.0

)%

Interest expense consists of interest payments on our
convertible debt, non-cash interest charges for the amortization
of debt issuance and discount costs related to such debt and
related warrants. Interest expense for 2003 was attributable to
interest payable on our Series E and Series F
convertible notes which were converted together with accrued
interest to Series E and Series F redeemable
convertible preferred stock in June 2003. No convertible notes
or other indebtedness was outstanding in 2004, and therefore we
incurred no interest expense.

Interest income

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

Interest income

$

411

$

60

$

351

583.6

%

Interest income relates to interest we earn on our money market
deposits and short-term investments. Interest income will
fluctuate as our cash and short-term investment balances change
and applicable interest rates increase or decrease. The increase
in interest income in 2004 compared to 2003 was due primarily to
interest earned on investing the proceeds from our initial
public offering in November, 2004.

Other income (expense), net

Year Ended

December 31,

Increase

Percent

2004

2003

(Decrease)

Change

(In thousands)

Other income (expense), net

$

(1

)

$

21

$

(22

)

(102.7

)%

Other income (expense), net consists of non-operating items,
which have not been significant to date.

We recorded a provision for income taxes in 2004 attributable to
federal and state alternative minimum taxes currently payable
due to limits on the amount of net operating losses that may be
applied against income earned in 2004 under current tax
regulations. In 2003, no provision for income taxes was recorded
due to our net loss position. At December 31, 2004, we
maintained a full valuation allowance against our deferred tax
assets based on the determination that it was more likely than
not that the deferred tax assets would not be realized.

LIQUIDITY AND CAPITAL RESOURCES

Prior to our initial public offering in November 2004, we funded
our operations primarily through the sale of preferred stock and
convertible notes, which provided us with aggregate net proceeds
of approximately $65.8 million. In November 2004 we
completed our initial public offering, which raised net
proceeds, after underwriting discounts, commissions and
expenses, of approximately $61.4 million.

As of December 31, 2005 and 2004, we had cash, cash
equivalents and short-term investments of $88.9 million and
$83.5 million, respectively. We had no bank debt, line of
credit or equipment facilities at December 31, 2005 and
2004.

Operating activities

Our operating activities generated cash in the amount of
$8.6 million and $4.6 million during 2005 and 2004,
respectively, and used cash of $0.2 million in 2003. Cash
generated in 2005 and 2004 was primarily due to growth in our
business, and, in 2005, additionally to the accrual of
$3.2 million for litigation settlement, which was
subsequently paid in February 2006. Uses of cash in 2003 were
primarily to fund net losses and changes in working capital.

Our primary source of operating cash flow is the collection of
our commission income from escrow companies or similar
intermediaries in the real estate transaction closing process.
Due to the structure of our commission arrangements, our
accounts receivable are converted to cash on a short-term basis
and our accounts receivable balances at period end have
historically been significantly less than one months net
revenues. Our operating cash flows will be impacted in the
future by the timing of payments to our vendors for accounts
payable, which are generally paid within the invoice terms and
conditions. Our cash outflows are also impacted by the timing of
the payment of our accrued liabilities relating to commissions
and related compensation costs and client acquisition costs.

A number of non-cash items have been charged to expense and
decreased our net income or increased our net loss. These items
include depreciation and amortization of property and equipment,
amortization of debt discounts and non-cash interest expense
relating to our debt arrangements, and amortization of deferred
employee stock-based compensation expense and other stock-based
charges. To the extent these non-cash items increase or decrease
in amount and increase or decrease our future operating results,
there will be no corresponding impact on our cash flows. In
2005, the release of our deferred tax valuation allowance
generated a non-cash tax benefit of $16.8 million.

On November 30, 2005, we entered into a definitive
amendment to our existing lease of our corporate offices. Under
the amendment, our headquarters were relocated from a
15,825 square foot space on the 15th floor to a
23,803 square foot space on the 3rd floor of the same
building. The amendment extended the previous lease term from
January 31, 2007 to January 31, 2012, and reduced the
monthly base rent from $37.32 per square foot to an initial
monthly base rent of $25.32 per square foot, subject to a
3.5% annual escalator. As a result of the amendment, our
operating lease commitments increased by approximately
$3.4 million, principally associated with the extension of
the lease term.

Investing activities

Our investing activities used cash in the amount of
$13.8 million, $73.6 million and $0.3 million in
2005, 2004 and 2003, respectively. Uses of cash for investing
activities were primarily related to purchases and sales

of property and equipment and net purchases of short-term
investments. In November 2004, we purchased $72.1 million
in short-term investments using cash proceeds from our initial
public offering.

We primarily maintain a minimum amount of cash and cash
equivalents for operational purposes and invest the remaining
amount of our cash in investment grade, highly liquid
interest-bearing securities which allows for flexibility in the
event our cash needs change.

Currently, we expect our 2006 capital expenditures to be
approximately $4.3 million, with approximately
$2.4 million to be spent in the first quarter of 2006.
Capital expenditures in 2006 include approximately
$1.8 million of capitalized costs in connection with the
relocation and build-out of the new corporate office space, the
outfitting of field offices as we begin operations in new
markets during the year and improvements to existing field
offices. Capital expenditures are also expected to include
$2.5 million to increase server capacity and purchase
computer equipment and software. In the future, our ability to
make significant capital investments may depend on our ability
to generate cash flow from operations and to obtain adequate
financing, if necessary and available.

Financing activities

Our financing activities provided cash in the amount of
$0.6 million, $70.1 million and $1.9 million in
2005, 2004 and 2003, respectively. Sources of cash from
financing activities in 2005 primarily represented the proceeds
from stock option exercises. In 2004, sources of cash primarily
represented proceeds from the issuance of our convertible
preferred stock and related warrants, preferred stock warrant
and stock option exercises as well as our initial public
offering in November 2004. In 2003, the primary source of cash
represented proceeds from issuance of convertible notes payable,
offset partially by to the repayment on capital lease
obligations. At December 31, 2005, we no longer had any
capital lease obligations.

As of December 31, 2005, we had warrants outstanding for
the purchase of an aggregate of 4,603,000 shares of our
common stock at a weighted average exercise price of
$3.94 per share. All of these warrants are currently
exercisable at the option of the holders. If all or a portion of
these warrants were exercised for cash, we could receive
significant proceeds at that time.

Future needs

We believe that cash flows from operations and our current cash,
cash equivalents and short-term investments will be sufficient
to fund our operations for at least the next 12 months. Our
future capital requirements will depend on many factors,
including our rate of growth into new geographic markets, our
level of investment in technology and advertising initiatives.
Although we are currently not a party to any agreement or letter
of intent with respect in investments in, or acquisitions of,
complementary businesses, products or technologies, we may enter
into these types of arrangements in the future, which could also
require us to seek additional equity or debt financing. We
currently have no bank debt or line of credit facilities. In the
event that additional financing is required, we may not be able
to raise it on terms acceptable to us or at all. If we are
unable to raise additional capital when desired, our business,
operations and results will likely suffer.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

We lease office space and equipment under non-cancelable
operating leases with various expiration dates through January
2012. The following table provides summary information
concerning our future contractual obligations and commitments at
December 31, 2005.

We do not have any off balance-sheet arrangements, investments
in special purpose entities or undisclosed borrowings or debt.
Additionally, we are not a party to any derivative contracts or
synthetic leases.

EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1 titled The Company and Summary of
Significant Accounting Policies of our Notes to Financial
Statements for a full description of recent accounting
pronouncements including the respective expected dates of
adoption.

Item 7A.

Quantitative and Qualitative Disclosures About Market
Risk:

Interest rate sensitivity

We have minimal interest rate exposure on our investments. Our
investment policy requires us to invest funds in excess of
current operating requirements. The principal objectives of our
investment activities are to preserve principal, provide
liquidity and maximize income consistent with minimizing risk of
material loss.

As of December 31, 2005 and 2004, our cash and cash
equivalents consisted primarily of money market funds and our
short-term investments consisted primarily of investment grade,
highly liquid interest-bearing securities. The recorded carrying
amounts of cash and cash equivalents approximate fair value due
to their short maturities and short-term investments are carried
at fair value. The amount of credit exposure to any one issue,
issuer and type of instrument is limited. Our interest income is
sensitive to changes in the general level of interest rates in
the United States, particularly since the majority of our
investments are fixed income investments. If market interest
rates were to increase or decrease immediately and uniformly by
10% from levels at December 31, 2005 and 2004, the increase
or decline in fair market value of the portfolio would be
approximately $0.2 million and $0.4 million,
respectively.

Exchange rate sensitivity

We consider our exposure to foreign currency exchange rate
fluctuations to be minimal, as we do not have any sales
denominated in foreign currencies. We have not engaged in any
hedging or other derivative transactions to date.

We have completed an integrated audit of ZipRealty, Inc.s
2005 financial statements and of its internal control over
financial reporting as of December 31, 2005, and audits of
its 2004 and 2003 financial statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Our opinions, based on our audits, are
presented below.

Financial statements and financial statement
schedules

In our opinion, the financial statements listed in the
accompanying index present fairly, in all material respects, the
financial position of ZipRealty, Inc. at December 31, 2005
and 2004, and the results of its operations and its cash flows
for each of the three years in the period ended
December 31, 2005 in conformity with accounting principles
generally accepted in the United States of America. In addition,
in our opinion, the financial statement schedules listed in the
accompanying index present fairly, in all material respects, the
information set forth therein when read in conjunction with the
related financial statements. These financial statements and
financial statement schedules are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements and financial statement
schedules based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

Internal control over financial reporting

Also, in our opinion, managements assessment, included in
Managements Report on Internal Control Over Financial
Reporting appearing under Item 9A, that the Company
maintained effective internal control over financial reporting
as of December 31, 2005 based on criteria established in
Internal Control  Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects,
based on those criteria. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control 
Integrated Framework issued by the COSO. The Companys
management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on managements
assessment and on the effectiveness of the Companys
internal control over financial reporting based on our audit. We
conducted our audit of internal control over financial reporting
in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over
financial reporting was maintained in all material respects. An
audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and
evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we consider
necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinions.

A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation

of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.

Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

ZipRealty, Inc. (the Company), previously known as
ZipRealty.com, is a full-service real estate brokerage firm
incorporated in the State of California on January 25, 1999
and reincorporated in Delaware on August 9, 2004.
Headquartered in the San Francisco Bay Area, the Company
provides brokerage services to buyers and sellers through its
employee-agents in Arizona, California, Florida, Georgia,
Illinois, Maryland, Massachusetts, Nevada, Texas, Virginia,
Washington, and Washington, D.C. The Company provides
consumers the opportunity to access Multiple Listing Services,
or MLS, data through its website, and offers a lower commission
structure than is typical in the industry. Buyers are offered a
commission rebate at the close of a transaction, while sellers
are charged a reduced commission.

Stock split

In August 2004, the Companys stockholders approved a
reverse stock split of the Companys common and redeemable
convertible preferred stock in a range of one for two to one for
three shares. The actual split ratio of one for three shares of
the Companys common and redeemable convertible preferred
stock was approved by the Board of Directors on October 21,
2004, following stockholder approval of the range. On
November 8, 2004, the reverse stock split became effective.
All share, per share and stock option data information in the
financial statements for all periods have been retroactively
restated to reflect the reverse stock split.

Initial public
offering

On November 9, 2004, the Securities and Exchange Commission
declared effective the Companys Registration Statement on
Form S-1 (File
No. 333-115657)
for the initial public offering. The Company commenced the
offering immediately thereafter. The Company completed the sale
of 4,550,000 shares of common stock on November 15,
2004 at a price of $13.00 per share, and on
November 18, 2004 the Company sold the remainder of the
registered shares of common stock (682,500 shares) at the
same price per share pursuant to the underwriters exercise
of the over-allotment option. UBS Securities LLC, Deutsche Bank
Securities Inc., Thomas Weisel Partners LLC and Pacific Growth
Equities, LLC acted as the underwriters for the offering.

The aggregate purchase price of the offering was $68,022,500.
The net offering proceeds received by us after deducting total
estimated expenses were $61,402,757. We incurred total estimated
expenses in connection with the offering of $6,619,743, which
consisted of $1,795,943 in legal, accounting and printing fees,
$4,761,575 in underwriters discounts, fees and
commissions, and $62,225 in miscellaneous expenses. No payments
for such expenses were made directly or indirectly to
(i) any of our directors, officers or their associates,
(ii) any person owning 10% or more of any class of our
equity securities or (iii) any of our affiliates.

Upon the closing of the Companys initial public offering
on November 15, 2004, 13,025,620 shares of outstanding
redeemable convertible preferred stock converted into common
stock. Therefore, at December 31, 2005 and 2004, there were
no shares of outstanding redeemable convertible preferred stock.

All outstanding warrants to acquire preferred stock
automatically became exercisable for common stock upon the
closing of the Companys initial public offering.

Certain prior year amounts have been reclassified to conform to
the current periods presentation.

Risks and uncertainties

The Company is subject to certain risks and uncertainties.
Changes in any of the following areas, for example, could have a
negative effect on the Company in terms of its future financial
position, results of operations or cash flows:



regulatory changes;



the continued use and adoption of the Internet by consumers
which allows the Company to compete with established real estate
firms, many of which have long operating histories and
substantial client bases; and



entry into market of companies attempting to replicate the
Companys business model.

Net income (loss) per share

Basic net income (loss) per share is computed by dividing the
net income (loss) available to common stockholders for the
period by the weighted average number of shares of common stock
outstanding. Net income (loss) available to common stockholders
is calculated using the two class method as the net income
(loss) less cumulative preferred stock dividends for the period
and amounts allocated to preferred stock to reflect the
participation right of the preferred stock to share in dividends
together with common stock. Diluted income (loss) per share is
computed by dividing net income (loss) available to common
stockholders for the period by the weighted average number of
shares of common stock outstanding plus, if dilutive, potential
common shares outstanding during the period. Potential common
shares are composed of incremental shares of common stock
issuable upon the exercise of potentially dilutive stock options
and warrants and upon conversion of the Companys preferred
stock.

Use of estimates

The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could
differ from those estimates.

Revenue recognition

The Company derives the majority of its revenue from commissions
earned as agents to buyers and sellers on purchase or sale
transactions.

Commission revenue is recognized upon closing of a sale and
purchase transaction, net of any rebate or commission discount
or transaction fee adjustment, as evidenced by the closure of
the escrow or similar account and the transfer of funds to all
appropriate parties. Non-commission revenue is recognized from
its other business relationships, such as its
E-LOAN marketing
relationship, as the fees are earned from the other party,
typically on a monthly fee basis. Revenue is recognized provided
there is persuasive evidence of an arrangement, the price is
fixed or determinable, collectibility is reasonably assured and
the transaction has been completed.

Commission expenses to agents are recognized concurrently with
the related revenues. All other costs and expenses are
recognized when incurred.

Cost of revenues

Cost of revenues consists of commissions, related payroll taxes,
benefits and expense allowances paid to the Companys
ZipAgents, and the amortization of internal-use software and
website development costs which relate primarily to the
Companys ZipAgent Platform.

Cash and cash equivalents

The Company considers all highly liquid investments purchased
with an original maturity of three months or less to be cash
equivalents. At December 31, 2005 and 2004, $2,762,000 and
$10,765,000, respectively, of money market funds and repurchase
agreements, the fair value of which approximates cost, is
included in cash and cash equivalents.

Short-term investments

The Company classifies fixed income securities with a maturity
of over twelve months from the balance sheet date as short-term
investments based on the funds being available for use in
current operations, if needed. To date all fixed income
securities have been classified as available-for-sale and
carried at fair value, which is determined based on quoted
market prices, with unrealized gains or losses, net of tax
effects, included in accumulated other comprehensive income
(loss) in the accompanying financial statements. Interest and
amortization of premiums and discounts for fixed income
securities are included in other income (expense), net, in the
accompanying financial statements. Realized gains and losses are
calculated using the specific identification method.

Restricted cash

The Companys restricted cash balances at December 31,
2005 and 2004, includes $90,000 and $190,000, respectively,
which serves as collateral to a letter of credit that was issued
to the Companys landlord as a security deposit in
connection with a facility lease agreement. The letter of credit
expires in November 2006.

Fair value of financial instruments

The carrying amounts of the Companys financial
instruments, which include cash and cash equivalents, short-term
investments, accounts receivable, restricted cash, accounts
payable and accrued expenses, approximate their fair values due
to their short maturities.

Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash
equivalents, investments, accounts receivable and restricted
cash.

The Company deposits its cash and cash equivalents with
financial institutions that management believes to be of high
credit quality and these deposits may on occasion exceed
federally insured limits. At December 31, 2005,
substantially all of the Companys cash and cash
equivalents and short-term investments were managed by one
financial institution. The fair value of these investments are
subject to fluctuations based on market prices.

Substantially all of the Companys accounts receivable are
derived from commissions earned and are due from escrow and
other residential real estate transfer agents. These accounts
receivable are typically

unsecured. Allowances for credit losses and expected transaction
price adjustments are provided for in the financial statements
and have been within managements expectations. No escrow
or other transfer agent accounted for more than 10% of gross
accounts receivable at December 31, 2005 or 2004.

The Company derived 51%, 61% and 60% of its net transaction
revenues during the years ended December 31, 2005, 2004 and
2003, respectively, in the state of California. No customers
accounted for more than 10% of net revenues in 2005, 2004, or
2003.

The Company generates leads for ZipAgents through many sources,
including leads from third parties with which the Company has
only non-exclusive, short-term agreements that are generally
terminable on little or no notice and with no penalties. The
cost of these leads are included in marketing and business
development expenses. The Companys largest third-party
lead source, HomeGain, Inc., which is a competitor for online
customer acquisition, generated approximately 29% and 21% of the
Companys leads during 2005 and 2004, respectively. In
2005, Google generated approximately 12% of the Companys
leads.

Property and equipment

Property and equipment are stated at cost. Equipment under
capital leases is capitalized at the present value of the future
minimum lease payments. Leasehold improvements and assets
acquired pursuant to capital leases are amortized on the
straight-line basis over the shorter of the lease period or
their estimated useful lives. Depreciation and amortization is
computed using the straight-line method over the estimated
useful lives of the property and equipment as follows:

Computer hardware and software

1-3 years

Furniture, fixtures and equipment

4-5 years

Leasehold improvements

Shorter of the lease period or estimated useful life

When assets are sold or retired, the cost and accumulated
depreciation and amortization are eliminated from the accounts
and any resulting gains or losses are recorded in operations in
the period realized. Maintenance and repairs are expensed as
incurred. Expenditures which substantially increase an
assets useful life or improves an assets
functionality, are capitalized.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS No. 144), the
Company periodically evaluates the carrying value of long-lived
assets to be held and used when events and circumstances warrant
such a review. The carrying value of a long-lived asset is
considered impaired when the anticipated undiscounted cash flow
from such asset is less than its carrying value. In that event,
a loss is recognized based on the amount by which the carrying
value exceeds the fair value of the long-lived asset. Fair value
is determined primarily using the anticipated cash flows
discounted at a rate commensurate with the risk involved. Losses
on long-lived assets to be disposed of are determined in a
similar manner, except that fair values are reduced for the cost
of disposal.

Accounting for Stock-Based Compensation 
Transaction and Disclosure (SFAS 148).
Under APB 25, compensation expense is based on the
difference, if any, on the date of the grant, between the fair
value of the Companys stock and the exercise price of the
option. The Company amortizes deferred stock-based compensation
using the straight-line method.

The Company accounts for equity instruments issued to
non-employees in accordance with the provisions of SFAS 123
and Emerging Task Force Issue No. 96-18, Accounting for
Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or
Services(EITF 96-18).

The following table illustrates the effect on net income (loss)
if the Company had applied the fair-value recognition provisions
of SFAS 123, as amended by SFAS 148, to stock-based
employee compensation.

Year Ended December 31,

2005

2004

2003

(In thousands)

Net income (loss) as reported

$

20,467

$

3,184

$

(4,583

)

Add: Stock-based compensation expense included in reported net
income (loss), net of taxes

126

159

85

Deduct: Total stock-based employee compensation expense
determined under the fair value based method for all awards, net
of taxes

(1,238

)

(538

)

(378

)

Pro forma net income (loss)

$

19,355

$

2,805

$

(4,876

)

Net income (loss) per share, as reported:

Basic

$

1.02

$



$

(3.57

)

Diluted

$

0.82

$



$

(3.57

)

Pro forma income (loss) per share:

Basic

$

0.96

$



$

(3.77

)

Diluted

$

0.77

$



$

(3.77

)

Stock-based employee compensation expense determined under the
fair value based method for non-qualified options issued
pursuant to the stock option plans are tax-effected as
stock-based compensation charges associated to these options are
generally deductible on the Companys income tax returns.
Stock-based employee compensation expense determined under the
fair value based method for incentive stock options issued
pursuant to the stock option plans are not tax effected as
stock-based compensation charges associated to these options are
not deductible on the Companys income tax returns.

The fair value of each option grant is estimated on the date of
grant using the following weighted average assumptions:

Year Ended December 31,

2005

2004

2003

Expected volatility

33 - 61

%(2)

21 - 50

%(2)

0

%(1)

Risk-free interest rate

3.82 - 4.43

%

2.51 - 3.70

%

1.86 - 3.01

%

Expected life

4 years

4 years

4 years

Expected dividend yield

0

%

0

%

0

%

(1)

In fiscal years 2002 and 2003, the Company was a non-public
Company and, therefore, used the minimum value method under
which volatility is not considered.

The Company used the minimum value method until the initial
Form S-1 was filed
on May 20, 2004. The Company used a 50% volatility from
May 20, 2004 until the effective date of the initial public
offering on November 9, 2004. After this date the Company
used historical volatility rates.

The per share weighted average fair value of options granted
during the years ended December 31, 2005, 2004 and 2003 was
$5.06, $2.68 and $1.07, respectively.

The accounting for and disclosure of employee and non-employee
equity instruments, primarily stock options, requires judgment
by management on a number of assumptions, including the fair
value of the underlying instrument prior to the filing of the
registration statement for an initial public offering, estimated
lives of the outstanding instruments, and the instruments
volatility prior to the filing of the registration statement for
an initial public offering. Changes in key assumptions will
impact the valuation of such instruments.

Software and Website Development Costs

The Company follows the guidance of Emerging Issues Task Force
(EITF) No. 00-02, Accounting for Website
Development Costs. EITF
No. 00-02 sets
forth the accounting for website development costs based on the
website development activity. The Company follows the guidance
set forth in Statement of Position (SOP) 98-1,
Accounting for the Cost of Computer Software Developed or
Obtained for Internal Use, in accounting for the development
of the ZipAgent Platform. Costs incurred in the planning stage
are expensed as incurred while costs incurred in the application
and infrastructure stage are capitalized, assuming such costs
are deemed to be recoverable. Costs incurred in the operating
stage are capitalized or expensed, depending on the nature of
the cost. The planning stage ends when the functional
specifications for a release are complete. Costs incurred
relating to architecture design and coding that result in
additional functionality are capitalized in the application and
infrastructure stage. These costs principally relate to payroll
costs for employees directly involved in the development
process. Capitalized internal-use software costs, included in
property and equipment, are amortized over the softwares
useful life, which is generally fifteen months. Capitalized
internal-use software costs are amortized to cost of revenues.
Costs incurred in connection with the research and development
of the Companys product and technology, other than those
accounted for under SOP 98-1, are expensed as incurred to
product development.

The Company capitalized $638,000 and $556,000 in internal-use
software costs during the years ended December 31, 2005 and
2004, respectively. Amortization expense totaled $662,000,
$444,000, and $451,000, during the years ended December 31,
2005, 2004 and 2003, respectively, and is included in cost of
revenues. The amount of unamortized internal-use software costs
at December 31, 2005 and 2004 was $477,000 and $447,000,
respectively, and is included in property and equipment.

Advertising Costs

The costs of advertising are expensed as incurred. Advertising
expense was $759,000, $1,345,000 and $306,000 for the years
ended December 31, 2005, 2004 and 2003, respectively. Such
expense is included in sales and marketing expense.

Income Taxes

Deferred tax assets and liabilities arise from the differences
between the tax basis of an asset or liability and its reported
amount in the financial statements as well as from net operating
loss and tax credit carry forwards. Deferred tax amounts are
determined by using the tax rates expected to be in effect when
the taxes will actually be paid or refunds received, as provided
under current enacted tax law. Valuation allowances are
established when necessary to reduce deferred tax assets to the
amount expected to be realized. Income tax

expense or benefit is the tax payable or refundable,
respectively, for the period plus or minus the change during the
period in deferred tax assets and liabilities.

Comprehensive Income (Loss)

Comprehensive income (loss) is the sum of net income (loss) and
unrealized gains (losses) on available-for-sale securities.
Unrealized gains (losses) on investments are excluded from net
income (loss) and are reported in accumulated other
comprehensive income (loss) in the accompanying financial
statements.

Segment Reporting

The Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related
Information, establishes standards for reporting information
about operating segments in a companys financial
statements. Operating segments are defined as components of an
enterprise about which separate financial information is
available that is evaluated regularly by the chief operating
decision maker (the Companys Chief Executive Officer), or
decision making group, in deciding how to allocate resources and
in assessing performance. The Company operates in one segment.
All net revenues were derived from transactions in the United
States. All long-lived assets are located in the United States.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS 123 (Revised 2004),
Share-Based Payment(SFAS 123R). The new
pronouncement replaces the existing requirements under
SFAS 123 and APB 25. According to SFAS 123R, all
forms of share-based payments to employees, including employee
stock options and employee stock purchase plans, would be
treated the same as any other form of compensation by
recognizing the related cost in the statement of operations.
This pronouncement eliminates the ability to account for
stock-based compensation transactions using APB 25 and
requires all share-based payments to employees, including grants
of employee stock options, to be recognized in the financial
statements based n their grant date fair values. SFAS 123R
is effective for awards and stock options granted, modified or
settled in cash for annual periods beginning after June 15,
2005. SFAS 123R provides transition alternatives for public
companies to restate prior interim periods or prior years. The
pro forma disclosures previously permitted under SFAS 123
no longer will be an alternative to financial statement
recognition. On March 29, 2005 the Securities and Exchange
Commission (SEC) issued Staff Accounting
Bulletin No. 107 (SAB 107) which provides
the SEC Staffs views regarding interactions between
SFAS 123R and certain SEC rules and regulations and
provides interpretations of the valuation of share-based
payments for public companies. The Company will adopt
SFAS 123R in the first quarter of 2006 using the modified
prospective method. The Company will apply the Black-Scholes
model to estimate the fair value of share-based payments to
employees, which will then be amortized on a ratable basis over
the requisite service period. The Company is evaluating the
requirements of SFAS 123R and SAB 107 and expects that
the adoption of SFAS 123R will have a material impact on
the Companys results of operations and earnings per share
beginning in the first quarter of 2006. The Companys
assessment of the estimated compensation charges is affected by
the Companys stock price as well as assumptions regarding
a number of complex and subjective variables and the related tax
impact resulting in uncertainty as to whether future stock-based
compensation expense will be similar to the historical
SFAS 123 pro forma expense. These variables include, but
are not limited to, the volatility of our stock price and
employee stock option exercise behaviors.

In December 2004, the FASB issued FASB Staff Position
No. FAS 109-1 (FAS 109-1),
Application of FASB Statement No. 109,
Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs
Creation Act of 2004. The AJCA introduces a special 9% tax
deduction on qualified production activities. FAS 109-1
clarifies that this tax deduction should be accounted for as a
special tax deduction in accordance with Statement 109.
Pursuant to the AJCA, the Company will not

be able to claim this tax benefit until the first quarter of
fiscal 2006. The Company does not expect these new tax
regulations to have a material impact on its financial position,
results of operations or cash flows.

In March 2005, the FASB issued Financial Interpretation
No. 47, Accounting for Conditional Asset Retirement
Obligations (FIN 47). FIN 47 is an
interpretation of FASB Statement No. 143, Accounting
for Asset Retirement Obligations and clarifies
(i) that an entity is required to recognize a liability for
the fair value of a conditional asset retirement obligation when
incurred if the liabilitys fair value can be reasonably
estimated and (ii) when an entity would have sufficient
information to reasonably estimate the fair value of an asset
retirement obligation. Upon adoption in fiscal year 2006 the
Company does not anticipate that FIN 47 will have a
material impact on our financial statements.

In November 2005, the FASB issued FSP FAS 115-1 and
FAS 124-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments
(FSP 115-1), which provides guidance on determining
when investments in certain debt and equity securities are
considered impaired, whether that impairment is
other-than-temporary, and on measuring such impairment loss. FSP
115-1 also includes accounting considerations subsequent to the
recognition of an other-than temporary impairment and requires
certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. FSP 115-1 is
required to be applied to fiscal years beginning after
December 15, 2005. Upon adoption in fiscal year 2006 the
Company does not anticipate that FSP 115-1 will have a material
impact on our financial statements.

2.

BALANCE SHEET COMPONENTS

Short-term investments

At December 31, 2005 and 2004, short-term investments were
classified as available-for-sale securities, except for
restricted cash, and are reported at fair value as follows:

December 31, 2005

December 31, 2004

Gross

Gross

Estimated

Gross

Gross

Gross

Estimated

Amortized

Unrealized

Fair

Amortized

Unrealized

Unrealized

Fair

Cost

Losses

Value

Cost

Gains

Losses

Value

(In thousands)

(In thousands)

Money market securities

$

2,462

$



$

2,462

$

2,069

$



$



$

2,069

Repurchase agreements

300



300

5,396





5,396

Asset backed

9,056

(25

)

9,031

9,159



(10

)

9,149

Corporate obligations

38,187

(214

)

37,973

29,512



(61

)

29,451

US Government and agency obligations

35,288

(251

)

35,037

36,706

2

(36

)

36,672

Total short-term investments

$

85,293

$

(490

)

$

84,803

$

82,842

$

2

$

(107

)

$

82,737

December 31, 2005

December 31, 2004

(In thousands)

(In thousands)

Recorded as:

Cash equivalents

$

2,762

$

10,765

Short-term investments

82,041

71,972

$

84,803

$

82,737

At December 31, 2005, the fair value of the Companys
investments which had been in an unrealized loss position for
over twelve months was $39.6 million and the related
unrealized loss was approximately $179,000.

At December 31, 2004, the Companys unrealized losses
on investments were all in loss positions for less than
12 months.

The estimated fair value of short-term investments classified by
date of contractual maturity at December 31, 2005 is as
follows:

December 31,

2005

(In thousands)

Due within one year or less

$

50,105

Due after one year through two years

28,162

Due after two years through four years

6,536

$

84,803

Prepaid expenses and other current assets

Prepaid expenses and other current assets consist of the
following:

December 31,

2005

2004

(In thousands)

Prepaid expenses

$

2,101

$

1,211

Interest receivable

858

735

Other assets

270

168

3,229

2,114

Less: long-term portion

91

12

Prepaid expenses and other current assets

$

3,138

$

2,102

Property and equipment, net

Property and equipment, net consists of the following:

December 31,

2005

2004

(In thousands)

Computer hardware and software

$

4,812

$

3,574

Furniture, fixtures and equipment

901

391

Leasehold improvements

428

34

6,141

3,999

Less: accumulated depreciation and amortization

(3,603

)

(2,763

)

Property and equipment, net

$

2,538

$

1,236

Depreciation and amortization expense, excluding amortization of
leased assets, for the years ended December 31, 2005, 2004
and 2003 was $1,518,000, $847,000 and $726,000 respectively.

Computer hardware and software acquired under capital lease
arrangements were fully amortized at December 31, 2005 and
2004. Amortization expense relating to property and equipment
under capital leases totaled $131,000, for the year ended
December 31, 2003. Included in property and equipment at
December 31, 2005 and 2004 is approximately
$2.2 million and $1.8 million, respectively of fully
depreciated property and equipment still in use.

Due to uncertainty surrounding the realization of its deferred
tax assets based on its history of losses, the Company recorded
a full valuation allowance against its net deferred tax assets
at December 31, 2004 and 2003. During the fourth quarter of
2005, the Company concluded that a significant portion of the
valuation allowances were no longer necessary as available
evidence, including recent historical results and
managements expectations for the future, supported a more
likely than not conclusion that the related deferred tax assets
would be realized. As a result, the tax benefit for the year
ended December 31, 2005 includes a non-cash benefit of
$16.8 million related to the reduction of the valuation
allowance. The valuation allowance decreased by
$18.0 million and $1.7 million during the years ended
December 31, 2005 and 2004, respectively, and increased by
$1.6 million during the year ended 2003. The Company has
concluded that it is more likely than not that a portion of the
deferred tax assets will not be realized and therefore, the
Company has recorded a valuation allowance of $192,000 at
December 31, 2005. This valuation allowance relates to a
component of Other Comprehensive Income, as such if this asset
were to be realized the benefit would by recorded to Other
Comprehensive Income with no effect on the Companys net
income.

The Companys income taxes payable for federal and state
purposes have been reduced by the tax benefits associated with
utilization of net operating loss carryovers and the exercise of
employee stock options during the year. The benefit applicable
to stock options were credited directly to stockholders
equity and amounts to $0.7 million and $0 for fiscal years
ended December 31, 2005 and 2004, respectively.

At December 31, 2005, the Company had approximately
$45 million of federal and $29 million of state net
operating loss carryforwards available to reduce future taxable
income which will begin to expire in 2020 for federal and 2010
for state tax purposes, respectively.

The Tax Reform Act of 1986 limits the use of net operating loss
and tax credit carryforwards in certain situations where changes
occur in the stock ownership. The Company has federal and state
net operating losses of approximately $1 million at
December 31, 2005 that are subject to annual limitations of
$20,000.

The difference between the Companys effective income tax
rate and federal statutory rate consisted of:

Year Ended December 31,

2005

2004

2003

Statutory federal tax rate

34.00

%

34.00

%

(34.00

)%

State tax rate, net of federal benefit

5.27

%

5.67

%

(3.64

)%

Change in valuation allowance

(479.15

)%

(44.13

)%

35.97

%

Other, net

(0.24

)%

7.18

%

1.67

%

Total provision for (benefit from) income taxes

(440.12

)%

2.72

%

0.00

%

Current and deferred income taxes recorded in the Companys
balance sheets consisted of the following:

December 31,

2005

2004

(In thousands)

Prepaid income taxes

$

57

$



Deferred income taxes, current

443



$

500

$



5.

CONVERTIBLE NOTES PAYABLE

Between February 2002 and April 2002, the Company issued
$8.8 million of convertible promissory notes. The notes
were due upon demand any time after the second anniversary and
accrued interest at a rate of 8% per annum. Per the terms
of the agreement, the principal amount of the notes, together
with the interest thereon, were convertible into shares of
Series E convertible preferred stock at a conversion price
of $3.93 per share. The notes were collateralized by all
assets of the Company. In connection with these notes, the
Company issued warrants to purchase 4,465,391 shares
of Series E-1 convertible preferred stock at an exercise
price of $3.93 per share (See Note 7).

In December 2002, the Company issued $10.8 million of
convertible promissory notes, which included $3.1 million
in interim bridge loans that had been issued in September 2002
and October 2002. The notes were due upon demand any time after
the second anniversary and accrued interest at a rate of
8% per annum. Per the terms of the agreement, the principal
amount of the notes, together with the interest thereon, were
convertible into shares of Series F convertible preferred
stock at a conversion price of $3.93 per share. The notes
were collateralized by all assets of the Company. In connection
with these notes, the Company issued warrants to
purchase 1,370,474 shares of Series F convertible
preferred stock at an exercise price of $3.93 per share
(See Note 7). In addition, in connection with the interim
bridge loans, the Company issued warrants to
purchase 582,061 shares of Series F convertible
preferred stock at an exercise price of $3.93 per share
(See Note 7).

In February 2003, the Company issued $2.1 million of
convertible promissory notes. The notes were due upon demand any
time after the second anniversary and accrued interest at a rate
of 8% per annum. Per the terms of the agreement, the
principal amount of the notes, together with the interest
thereon, were convertible

into shares of Series F convertible preferred stock at a
conversion price of $3.93 per share. The notes were
collateralized by all assets of the Company. In connection with
these notes, the Company issued warrants to
purchase 274,366 shares of Series F convertible
preferred stock at an exercise price of $3.93 per share
(See Note 7).

In June 2003, the Company issued 2,466,724 shares of the
Companys Series E convertible preferred stock in
exchange for the conversion of $8.8 million of convertible
promissory notes principal and $0.9 million of accrued
interest balances. In addition, the Company issued
3,420,534 shares of the Companys Series F
convertible preferred stock in exchange for the conversion of
$12.9 million convertible promissory notes principal and
$0.5 million of accrued interest balances. As a result of
these conversions, no amounts of convertible notes payable or
accrued interest were outstanding at December 31, 2005 or
2004.

In conjunction with the conversion, the Company issued warrants
to purchase 134,766 shares of
Series E-1
convertible preferred stock at an exercise price of
$3.93 per share and 198,567 shares of Series F
convertible preferred stock at an exercise price of
$3.93 per share. The Company estimated the fair value of
such warrants at $93,572 and $357,187 for the Series E-1
warrants and Series F warrants, respectively, using the
Black-Scholes model with the following assumptions: fair value
of the underlying stock of $2.28 and $3.93, respectively,
expected volatility of 50%, risk-free interest rate of 2.36%,
expected life of 5 years, and no dividends. The value of
the warrants was recorded as note payable conversion expense and
recorded in general and administrative expense. During 2005,
9,458 of these Series E-1 and 1,900 of these Series F
warrants were net exercised.

6.

COMMITMENTS AND CONTINGENCIES

Leases

The Company leases office space and equipment under
noncancelable operating leases with various expiration dates
through January 2012.

Rent expense for the years ended December 31, 2005, 2004
and 2003 was $1.2 million, $946,000 and $802,000,
respectively.

Legal Proceedings

On August 3, 2005, the Company was named in a class action
lawsuit filed in Superior Court of the State of California,
County of San Diego, Central Division, Sullivan,
et al v. ZipRealty, case number GIC851801, by two
former employee agents for the Company. The plaintiffs alleged,
among other things, that the

Companys expense allowance policies violated California
law. The Company reached an agreement to settle this claim in
exchange for the Companys payment of $4,164,000. The
agreement, which included a full release from any further
liability on this issue, was granted preliminary court approval
on October 21, 2005 and final court approval on
February 10, 2006. The Company made the final payment under
the settlement agreement in February 2006.

The Company is not currently subject to any other material legal
proceedings. From time to time the Company has been, and it
currently is, a party to litigation and subject to claims
incident to the ordinary course of the business. The amounts in
dispute in these matters are not material to the Company, and
management believes that the resolution of these proceedings
will not have a material adverse effect on the business, results
of operations, financial position or cashflows.

Indemnifications

The Company has entered into various indemnification agreements
in the ordinary course of our business. Pursuant to these
agreements, the Company has agreed to indemnify, hold harmless
and reimburse the indemnified parties, which include certain of
our service providers as well as others, in connection with
certain occurrences. In addition, the corporate charter
documents require the Company to provide indemnification rights
to the Companys directors and officers to the fullest
extent permitted by the Delaware General Corporation Law, and
permit the Company to provide indemnification rights to our
other employees and agents, for certain events that occur while
these persons are serving in these capacities. The Company has
also entered into indemnification agreements with the
Companys directors and each of our officers with a title
of Vice President or higher. Further, the underwriting agreement
for the Companys initial public offering requires the
Company to indemnify the underwriters and certain of their
affiliates and agents for certain liabilities arising from the
offering and the related registration statement.

The maximum potential amount of future payments the Company
could be required to make under these indemnification agreements
is unspecified. The Company is not aware of any material
indemnification liabilities for actions, events or occurrences
that have occurred to date. The Company maintains insurance on
some of the liabilities the Company has agreed to indemnify,
including liabilities incurred by the Companys directors
and officers while acting in these capacities, subject to
certain exclusions and limitations of coverage.

7.

REDEEMABLE CONVERTIBLE PREFERRED STOCK

At December 31, 2003, redeemable convertible preferred
stock consisted of the following:

Shares

Aggregate

Issued and

Liquidation

Authorized

Outstanding

Preference

Series A

1,911,112

629,626

$

1,700,000

Series B

5,246,171

1,734,752

16,393,438

Series C

2,178,486

547,343

10,000,005

Series D

6,106,871

2,006,357

9,531,544

Series E

9,000,000

2,466,724

29,082,849

Series E-1

15,300,000





Series F

19,600,000

3,420,534

26,885,452

Balance at December 31, 2003

59,342,640

10,805,336

$

93,593,288

Upon the closing of the Companys initial public offering
on November 15, 2004, 13,025,620 shares of outstanding
redeemable convertible preferred stock converted into common
stock. Therefore, at December 31, 2004 and 2005, there were
no shares of outstanding redeemable convertible preferred stock.

The holders of convertible preferred stock had various rights
and preferences as follows:

Voting

Each share of Series A, B, C, D, E,
E-1 and F had voting
rights equal to an equivalent number of shares of common stock
into which it was convertible and, except as set forth below,
generally voted together as one class with the common stock.

The holders of Series A, B and D were each entitled to
elect one member of the Board of Directors (BOD)
voting as a separate class. The holders of common stock were
entitled to elect two members of the BOD voting as a separate
class. Any remaining members of the BOD were elected by the
holders of common stock and preferred stock voting as a single
class.

As long as at least 500,000 shares of convertible preferred
stock remained outstanding, the Company had to obtain approval
from a majority of the holders of convertible preferred stock to
alter the authorized number of shares of convertible preferred
stock, repurchase any shares of common stock other than shares
subject to the right of repurchase by the Company, increase the
authorized number of BOD members, authorize a dividend or make
any distribution to the common stockholders, amend the Articles
of Incorporation or bylaws for changes which would adversely
impact the rights and preferences of convertible preferred
stock, dissolve, liquidate or wind up the Company, consummate a
change in control or create a new security senior to the
existing classes of preferred stock.

Dividends

Holders of Series A, B, C, E,
E-1 and F were entitled
to receive non-cumulative dividends at the per annum amount of
$0.216, $0.75, $1.47, $0.3144, $0.3144 and $0.3144 per
share, respectively, when and if declared by the BOD. The
holders of Series A, B, C, D, E,
E-1 and F were also
entitled to participate in dividends on common stock, when and
if declared by the BOD, based on the number of shares of common
stock held on an as-if converted basis. No dividends on
convertible preferred stock or common stock have been declared
by the BOD.

Holders of Series D were entitled to receive cumulative
dividends from the date of issuance of such shares, when and if
declared by the BOD, at a per annum amount of $0.3144 per
share payable in preference and prior to payment of any dividend
on Series A, B and C convertible preferred stock and common
stock.

Liquidation

Upon liquidation, dissolution or winding up of the Company, the
holders of Series F preferred stock were entitled to
receive an amount equal to $7.86 per share plus accrued
dividends prior and in preference to payments to holders of
Series A, B, C, D, E and
E-1 convertible
preferred stock and common stock. The holders of Series E
and E-1 preferred stock
were entitled to receive an amount equal to $11.79 and $3.93,
respectively, per share plus accrued dividends prior and in
preference to payments to holders of Series A, B, C and D
convertible preferred stock and common stock. The holders of
Series D preferred stock were entitled to receive an amount
equal to $3.93 per share plus accrued dividends prior and
in preference to payments to holders of Series A, B and C
convertible preferred stock and common stock. The holders of
Series A, B and C were entitled to receive an amount equal
to $2.70, $9.45 and $18.27 per share (adjusted to reflect
stock dividends, stock splits, reverse stock splits and the
like), respectively, plus any declared but unpaid dividends
prior to and in preference to any distribution to the holders of
common stock. If the Companys legally available assets
were insufficient to satisfy the Series A, B, and C
liquidation preferences, then all assets would have been
distributed ratably among the Series A, B and C
stockholders in proportion to their full preferential amount
due. The remaining assets, if any, were to be distributed to the
holders of common stock.

The acquisition of the Company by another entity in which the
stockholders of the Company own 50% or less of the voting stock
of the surviving company or the sale of substantially all of the
assets of the Company was to be deemed a liquidation,
dissolution, or winding up of the Company. As such, the
convertible preferred stock was classified as mezzanine
financing outside the stockholders deficit section on the
balance sheet.

Conversion

Each share of Series A, B, C, D, E,
E-1 and F was
convertible, at the option of the holder, at any time, according
to a conversion rate determined by dividing the issuance price
by the conversion price in effect at the time of the conversion,
subject to adjustment for dilution. Each share of Series A,
B, C, D, E, E-1, and F
automatically converted into the number of shares of common
stock into which such shares were convertible at the then
effective conversion rate upon: (i) the closing of the
public offering of common stock with gross proceeds of at least
$20 million or (ii) the consent of the holders of 70%
of Series E and
E-1, 75% of
Series F and
662/3%
of Series A, B, C and D convertible preferred stock.

All outstanding warrants to acquire preferred stock
automatically became exercisable for common stock upon the
closing of the Companys initial public offering in
November 2004. See Note 8 for additional discussion of
common stock warrants.

Warrant for services

In November 1999, the Company issued a warrant to
purchase 3,386 shares of Series B convertible
preferred stock at $9.45 per share for marketing expenses
incurred. The warrant was fully vested and exercisable
immediately and was net exercised in 2004.

Warrant with office lease

In connection with leasing office space, in June 2000, the
Company issued a warrant to the landlord to
purchase 4,979 shares of Series C at
$18.27 per share. The warrant was fully vested and
exercisable immediately and expired in March 2004. The warrant
was valued using the Black-Scholes pricing model and assumptions
used were as follows: fair value of the underlying stock of
$18.27; risk free interest rate of 5.75%; expected life of
4 years; no dividends during the term and volatility of
80%. The value of the warrant totaled $56,718 at the date of
grant and was recorded as deferred rent expense. In connection
with the lease termination in January 2002, the Company
amortized the remaining deferred rent expense in the amount of
$11,343 during the year ended December 31, 2002.

Warrants with equipment lease line

In connection with closing a $2 million equipment leasing
arrangement in August 2000, the Company issued warrants to
purchase 3,284 and 6,349 shares of Series C at
$18.27 and $9.45 per share, respectively. The warrants were
fully vested and exercisable immediately and expire in August
2010. These warrants were valued using the Black-Scholes pricing
model and assumptions used were as follows: fair value of the
underlying stock of $18.27 and $9.45, respectively; risk free
interest rate of 5.75%; expected life of 10 years; no
dividends during the term and volatility of 80%. The value of
the warrants totaled $50,833 and $103,944, respectively, at the
date of grant and was recorded as deferred interest expense. The
amount was amortized over the life of the lease line. The
related interest expense recorded for the years ended
December 31, 2005, 2004 and 2003 totaled $0, $0 and $9,573,
respectively. Warrants to acquire preferred stock automatically
became exercisable for common stock upon the closing of the
Companys initial public offering in November 2004. In
2005, 6,349 warrants were net exercised at $9.45 per share.
At December 31, 2005 the remaining 3,284 common stock
warrants had not been exercised.

In connection with interim financing provided by investors
during 1999, the Company issued warrants to the investors to
purchase 7,407 and 10,582 shares of Series A and
Series B convertible preferred stock at $2.70 and
$9.45 per share, respectively. The warrants expired in
March and November 2003. These warrants were valued using the
Black-Scholes pricing model and assumptions used were as
follows: fair value of the underlying stock of $2.70 and
$9.45 per share, respectively; risk free interest rate of
5.75%; expected life of 4 years; no dividends during the
term and volatility of 60%. The fair value of the warrants
issued totaled $61,620 at the date of grant and was recorded as
interest expense during 1999.

In connection with interim financing provided by investors
during 2002, the Company issued warrants to
purchase 582,061 shares of Series F convertible
preferred stock at $3.93 per share. The warrants expire in
October 2007. The warrants were valued using the Black-Scholes
pricing model and assumptions used were as follows: fair value
of the underlying stock of $3.93 per share; risk-free
interest rate of 2.98%; expected life of 5 years; no
dividends and volatility of 50%. The allocated value of the
warrants totaled $790,133 at the date of grant and was recorded
as interest expense during 2002. The warrants to acquire
preferred stock automatically became exercisable for common
stock upon the closing of the Companys initial public
offering in November 2004. At December 31, 2005, the
warrants had not been exercised.

In December 2002, the Company issued warrants to
purchase 1,370,474 shares of Series F convertible
preferred stock at an exercise price of $3.93 per share in
conjunction with the issuance of convertible promissory notes.
The warrants are immediately exercisable and expire five years
from the date of grant. The Company estimated the allocated fair
value of such warrants at $2,055,820 using the Black-Scholes
model with the following assumptions: fair value of the
underlying stock of $3.93 per share; expected volatility of
50%, risk-free interest rate of 2.96%, expected life of
5 years, and no dividends. The value of the warrants was
recorded as a debt discount and amortized as interest expense
using the effective interest method over the estimated life of
the notes, which was estimated to be 24 months. For the
December 31, 2003, interest expense related to such
warrants amounted to $411,986. The remaining unamortized balance
in the amount of $1,504,661 was recorded as preferred stock in
connection with the conversion of the convertible notes payable
(See Note 5). The warrants to acquire preferred stock
automatically became exercisable for common stock upon the
closing of the Companys initial public offering in
November 2004. During 2005, 15,745 of these warrants were net
exercised.

In February 2003, the Company issued warrants to
purchase 274,366 shares of Series F convertible
preferred stock at an exercise price of $3.93 per share in
conjunction with the issuance of convertible promissory notes.
The warrants are immediately exercisable and expire five years
from the date of grant. The Company estimated the allocated fair
value of such warrants at $408,782 using the Black-Scholes model
with the following assumptions: fair value of the underlying
stock of $3.93 per share; expected volatility of 50%,
risk-free interest rate of 2.87%, expected life of 5 years,
and no dividends. The value of the warrants was recorded as a
debt discount and amortized as interest expense using the
effective interest method over the estimated life of the notes,
which was estimated to be 24 months. For the year ended
December 31, 2003, interest expense related to such
warrants amounted to $59,295. The remaining unamortized balance
in the amount of $349,487 was recorded as Preferred Stock in
connection with the conversion of the convertible notes payable
(See Note 5).

Between February 2002 and April 2002, the Company issued
warrants to purchase 4,465,391 shares of
Series E-1 convertible preferred stock at an exercise price
of $3.93 per share in conjunction with the issuance of
convertible promissory notes. The warrants are immediately
exercisable and expire five years from the date of grant. In the
event the Company meets certain profitability goals for six
continuous months, the exercisability of one-half of these
warrants terminates. The Company estimated the allocated fair
value of such warrants at $1,987,705 using the Black-Scholes
model with the following assumptions: fair value of the
underlying stock of $1.95 per share, expected volatility of
50%, risk-free interest rate ranging from 4.31% to

4.70%, expected life of 5 years, and no dividends. The
value of the warrants was recorded as a debt discount and
amortized as interest expense using the effective interest
method over the estimated life of the notes, which was estimated
to be 24 months. For the years ended December 31, 2002
and 2003, interest expense related to such warrants amounted to
$621,350 and $463,671, respectively. The remaining unamortized
balance in the amount of $814,939 was recorded to preferred
stock in connection with the conversion of the convertible notes
payable (See Note 5). During 2004, warrants to
purchase 2,177,553 shares of
E-1 convertible
preferred stock had been exercised and warrants to acquire
65,682 shares of
E-1 convertible
preferred stock had been net exercised. The warrants to acquire
preferred stock automatically became exercisable for common
stock upon the closing of the Companys initial public
offering in November 2004. During 2005, 155,444 of these
warrants were cash and net exercised.

8.

PREFERRED AND COMMON STOCK

The Companys Certificate of Incorporation, as amended on
November 15, 2004, authorizes the Company to issue
5,000,000 shares of $0.001 per value preferred stock and
100,000,000 shares of $0.001 par value common stock.
As of December 31, 2005, no shares of preferred stock were
issued or outstanding.

Common stock warrants

In April 2003, the Company issued a warrant to
purchase 19,083 shares of common stock at
$0.99 per share for consulting services. The warrant was
fully vested and exercisable immediately. These warrants were
net exercised during 2005. The value of the warrant was not
material.

As discussed in Note 7 to the financial statements, all
outstanding warrants to acquire preferred stock automatically
became exercisable for common stock upon the closing of the
Companys initial public offering in November 2004. At
December 31, 2005, 4,603,000 common stock warrants remained
outstanding and exercisable under the above arrangements.

9.

STOCK OPTION PLANS

In February 1999, the BOD approved and the Company adopted the
1999 Stock Option Plan (the 1999 Plan). The 1999
Plan provides for the granting of stock options to employees and
consultants of the Company. Options granted under the 1999 Plan
may be either incentive stock options or nonstatutory stock
options. Incentive stock options (ISO) may be
granted only to Company employees (including officers and
directors who are also employees). Nonstatutory stock options
(NSO) may be granted to Company employees and
consultants. The Company has authorized and reserved
3,362,000 shares of common stock for issuance under the
1999 Plan; at December 31, 2005, 495,000 shares have
been exercised.

In August 2004, the BOD approved and the Company adopted the
2004 Equity Incentive Plan (the 2004 Plan). The 2004
Plan provides for the granting of stock options to employees and
consultants of the Company. Options granted under the 2004 Plan
may be either incentive stock options or nonstatutory stock
options. Incentive stock options (ISO) may be
granted only to Company employees (including officers and
directors who are also employees). Nonstatutory stock options
(NSO) may be granted to Company employees and
consultants. The Company has authorized and reserved
1,000,000 shares of common stock for issuance under the
2004 Plan; at December 31, 2005, no shares have been
exercised.

Following the Companys initial public offering, any shares
that were reserved but not issued under the 1999 Plan were made
available under the 2004 Plan, and any shares that would have
otherwise returned to the 1999 Plan will be made available for
issuance under the 2004 Plan. The 1999 Plan will continue to
govern awards granted there under prior to the Companys
initial public offering.

The number of shares reserved for issuance under the 2004 Plan
will be increased by the number of shares which have been
reserved but not issued under the 1999 Plan, any shares returned
to the 1999 Plan, and

an annual increase to be added on the first day of our fiscal
year beginning in 2006 equal to the least of
(a) 1,666,666 shares, (b) 4% of the outstanding
shares on such date, or (c) an amount determined by the
Board. Pursuant to this requirement, on January 1, 2006, an
additional 810,932 shares were added to the plan, reserved
for issuance and registered for sale under
Form S-8.

Options under the 1999 and 2004 Plans may be granted at prices
no less than 85% of the estimated fair value of the shares on
the date of grant as determined by the BOD, provided, however,
that (i) the exercise price of an ISO and NSO shall not be
less than 100% and 85% of the estimated fair value of the shares
on the date of grant, respectively, and (ii) the exercise
price of an ISO and NSO granted to a 10% stockholder shall not
be less than 110% of the estimated fair value of the shares on
the date of grant, respectively. Options generally vest over a
four-year period with one-fourth
(1/4)
of the shares vesting one year after the vesting commencement
date, and an additional one-forty eighth
(1/48)
of the shares vesting on the first day of each calendar month
thereafter until all such shares are exercisable. Options expire
after ten years.

The following table summarizes information about stock options
outstanding at December 31, 2005:

Options Vested and

Options Outstanding at

Exercisable at

December 31, 2005

December 31, 2005

Weighted

Weighted

Average

Weighted

Average

Remaining

Average

Option

Number

Contractual

Exercise

Number

Exercise

Range of Exercise Prices

Outstanding

Life (Years)

Price

Outstanding

Price

(Shares in thousands)

$0.30

3

3.6

$

0.30

3

$

0.30

$0.99

1,563

5.9

$

0.99

1,489

$

0.99

$1.50 - $6.00

205

7.4

$

3.81

113

$

3.68

$7.50

472

8.2

$

7.50

207

$

7.50

$8.30 - $11.25

307

8.7

$

9.88

101

$

10.03

$13.73

262

9.8

$

13.73

13

$

13.73

$13.88

143

9.6

$

13.88

6

$

13.88

$14.08

85

9.4

$

14.08

5

$

14.08

$14.75

105

9.2

$

14.75

9

$

14.75

$16.50

507

9.0

$

16.50

129

$

16.50

3,652

7.6

$

7.01

2,075

$

3.40

During the years ended December 31, 2005, 2004, and 2003,
the Company recorded $0, $430,000 and $260,000, respectively, of
deferred stock-based compensation for the excess of the fair
value of common stock over the exercise price at the date of
grant related to stock options granted to employees. The Company
amortized $140,000 and $159,000 and $85,000 to compensation
expense in the years ended December 31, 2005, 2004 and 2003
respectively.

The intrinsic value per share is being recognized as
compensation expense on a straight line basis over the
applicable vesting period (which equals the service period). The
fair value of the common stock for options granted prior to the
Companys initial public offering was retrospectively
estimated by the board of directors, with input from management.
The fair value of the common stock for options granted following
the Companys initial public offering was the closing price
of the Companys common stock on the Nasdaq National Market
on the date of the grant.

Stock option exchange program

On August 1, 2001, the Company announced a voluntary stock
option exchange program for its employees. Under the program,
employees had the opportunity to cancel the outstanding stock
options previously granted to them under the Plan in exchange
for an equal number of new options to be granted at a future
date, at least six months and a day from the cancellation date,
which was August 29, 2001. A total of 280,483 options were
cancelled in connection with the option exchange. The exercise
price of the new options was equal to the fair value of the
Companys common stock at the date of the new grant, which
was on March 4, 2002. The Company granted stock options to
purchase 224,217 shares of the Companys common
stock on March 4, 2002 at an exercise price of
$0.99 per share. Of the 280,483 options cancelled, 56,267
options were not re-granted due to employee terminations.

10.

EMPLOYEE BENEFIT PLAN

The Company has a 401(k) profit sharing plan covering all
eligible employees. Employees may contribute amounts ranging
from 1% to 50% of their annual salary, up to the maximum
statutory amount. The

Company is not required to contribute to the plan and has made
no such contributions through December 31, 2005. Beginning
January 1, 2006 the Company has elected to match 25% of the
first 4% of employee contributions to the plan.

11.

UNAUDITED QUARTERLY FINANCIAL DATA

The following table sets forth our selected unaudited quarterly
operating information for each of the eight quarters ended
December 31, 2005. This information has been prepared on
the same basis as the audited financial statements contained in
this report and includes all normal recurring adjustments
necessary for the fair statement of the information for the
periods presented, when read together with our financial
statements and related notes. Our future operating results are
difficult to predict and may vary significantly. Results for any
fiscal quarter are not necessarily indicative of results for the
full year or for any future quarter.

Fourth

Third

Second

First

Year Ended December 31, 2005

Quarter

Quarter

Quarter

Quarter

(In thousands)

Net transaction revenues

$

20,960

$

27,576

$

25,228

$

17,318

Cost of revenues

11,646

15,555

13,820

10,063

Income (loss) from operations(a)

340

2,219

(1,616

)

82

Net income (loss)(b)

17,901

2,850

(946

)

662

Net income (loss) available to common shareholders

17,901

2,850

(946

)

662

Net income (loss) per share:

Basic

$

0.88

$

0.14

$

(0.05

)

$

0.03

Diluted

$

0.73

$

0.11

$

(0.05

)

$

0.03

Weighted average common shares outstanding:

Basic

20,260

20,198

20,005

19,885

Diluted

24,546

25,328

20,005

25,711

(a)

Includes a one-time charge of $4.2 million recorded in the
second quarter of 2005 related to the settlement of threatened
litigation.

(b)

Includes an income tax benefit of $16.8 million recorded in
the fourth quarter of 2005 related to a reversal of the
Companys valuation allowance primarily attributable to the
deferred tax assets related to net operating loss carryforwards.

Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure:

Not applicable.

Item 9A.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive
Officer and our Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such
items are defined in
Rule 13a-15(e) and
15d-15(e) under the
Securities Exchange Act of 1934, as amended (Exchange Act)) as
of the end of the period covered by this Annual Report on
Form 10-K. Based
on this evaluation, our Chief Executive Officer and our Chief
Financial Officer have concluded that our disclosure controls
and procedures as of the end of the period covered by this
Annual Report are effective to ensure that information we are
required to disclose in reports that we file or submit under the
Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding
required disclosure, and that such information is recorded,
processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.

Managements Report on Internal Control Over
Financial Reporting

Our management is responsible for establishing and maintaining
adequate internal control over financial reporting (as defined
in Rule 13a-15(f)
under the Exchange Act). Our management, including our CEO and
CFO, conducted an evaluation of the effectiveness of our
internal control over financial reporting as of
December 31, 2005. In making its evaluation, management
used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in
Internal Control  Integrated Framework.

Based on our evaluation, under the criteria set forth by COSO in
Internal Control  Integrated Framework, our
management concluded that our internal control over financial
reporting was effective as of December 31, 2005. Our
managements assessment of the effectiveness of our
internal control over financial reporting as of
December 31, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which is included
herein.

Our management, including our CEO and CFO, acknowledge that
because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial
Reporting

There were no changes in our internal control over financial
reporting during the quarter ended December 31, 2005 that
have materially affected, or are reasonably likely to materially
affect our internal control over financial reporting.

On March 14, 2006, the Compensation Committee of the Board
of Directors approved the salaries for named executive officers
described in Exhibit 10.12 to this report and approved the
2006 Management Incentive Plan described in Exhibit 10.13
to this report.

PART III

Item 10. Directors and Executive Officers:

Executive officers

The information required by this item with respect to executive
officers is incorporated by reference to Item 1 of this
report. That information can be found under the caption,
Executive Officers.

Directors

The information required by this item with respect to directors
is incorporated by reference to our Proxy Statement for our 2006
Annual Meeting of Stockholders under the caption,
Directors and, regarding our audit committee
financial expert, in the second sentence under the caption,
Board committees  Audit Committee.

Our Board of Directors has adopted a Code of Business Conduct
and Ethics that is applicable to all directors, officers and
employees, including our Chief Executive Officer, Chief
Financial Officer and Principal Accounting Officer and
Controller. The Code is available on our website at
www.ziprealty.com under Investor
Relations  Corporate Governance 
Governance Documents. We intend to disclose any amendment
to or waiver from a provision of the Code with respect to our
Chief Executive Officer, Chief Financial Officer and Principal
Accounting Officer and Controller, including the name of the
officer to whom the waiver was granted, on our website as set
forth above.

Item 11.

Executive Compensation:

The information required by this item with respect to executive
compensation is incorporated by reference to our Proxy Statement
for our 2006 Annual Meeting of Stockholders under the captions,
Director compensation, Executive
compensation, Change of control arrangements
and Compensation committee interlocks and insider
participation.

The information required by this item with respect to security
ownership of certain beneficial owners and management is
incorporated by reference to our Proxy Statement for our 2006
Annual Meeting of Stockholders under the caption, Security
Ownership by our Directors, Officers and Principal
Stockholders.

The following table provides information as of December 31,
2005 about our common stock that may be issued upon the exercise
of options, warrants and rights under our 1999 Stock Option Plan
and 2004 Equity Incentive Plan. Our stockholders have previously
approved these plans.

Number of Securities

Number of

Available for

Securities to be

Issuance Under

Issued Upon

Weighted-Average

Equity Compensation

Exercise of

Exercise Price of

Plans (Excluding

Outstanding Options,

Outstanding Options,

Securities Reflected

Plan Name and Type

Warrants and Rights

Warrants and Rights

in the First Column)

(In thousands)

(in thousands)

Equity compensation plans approved by stockholders

1999 Stock Option Plan

2,511

$

3.45



2004 Equity Incentive Plan

1,141

$

14.83

215

Total

3,652

$

7.01

215

Item 13. Certain Relationships and Related
Transactions:

The information required by this item is incorporated by
reference to our Proxy Statement for our 2006 Annual Meeting of
Stockholders under the caption, Significant Relationships
and Transactions with Directors, Officers or Principal
Stockholders.

Item 14. Principal Accountant Fees and
Services:

The information required by this item is incorporated by
reference to our Proxy Statement for our 2006 Annual Meeting of
Stockholders under the caption,
Proposal 3  Appointment of Independent
Registered Public Accounting Firm.

PART IV

Item 15. Exhibits and Financial Statement
Schedules:

(a)

Documents filed with this report:

1. Financial Statements.

The following financial statements and related report of
Independent Registered Public Accounting Firm are incorporated
in Item 8 of this report:



Report of independent registered public accounting firm



Balance Sheets at December 31, 2005 and 2004



Statements of Operations for the years ended December 31,
2005, 2004 and 2003



Statements of Stockholders Equity for the years ended
December 31, 2005, 2004 and 2003



Statements of Cash Flows for the years ended December 31,
2005, 2004 and 2003



Notes Financial Statements.

2. Financial Statement Schedule

Schedule II-Valuation and Qualifying Accounts for the three
fiscal years in the period ended December 31, 2005.

The following financial statement schedule of ZipRealty, Inc.
for each of the past three years in the period ended
December 31, 2005 should be read in conjunction with the
Financial Statements of ZipRealty, Inc.

Schedule II  Valuation and Qualifying
Accounts

Balance at

Charged to

Balance at

Beginning of

Costs and

End of

Description

Year

Expenses

Deductions

Year

(In thousands)

Fiscal year ended December 31, 2003

Provision for Doubtful Accounts

13

13

6

20

Deferred Tax Asset Valuation

18,241

1,641



19,882

Fiscal year ended December 31, 2004

Provision for Doubtful Accounts

20

9



29

Deferred Tax Asset Valuation

19,882



1,672

18,210

Fiscal year ended December 31, 2005

Provision for Doubtful Accounts

29

19

6

42

Deferred Tax Asset Valuation

18,210



18,018

192

All other financial statement schedules have been omitted
because they are not applicable or are not required, or because
the required information is included in the Financial Statements
and Notes thereto which are included herein.

3. Exhibits.

The exhibits listed in the Exhibit Index are filed as a
part of this report.

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

ZIPREALTY, INC.

By:

/s/ Gary M. Beasley

Gary M. Beasley

Executive Vice President and

Chief Financial Officer

Date: March 16, 2006

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Eric A.
Danziger and Gary M. Beasley, and each of them, his true and
lawful
attorneys-in-fact, each
with full power of substitution, for him in any and all
capacities, to sign any amendments to this report on
Form 10-K and to
file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of
said attorneys-in-fact
or their substitute or substitutes may do or cause to be done by
virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.